Tesst bank chapter 22 working capital management

CHAPTER 22
WORKING CAPITAL MANAGEMENT
(Difficulty: E = Easy, M = Medium, and T = Tough)

True-False
Easy:
Net working capital
1

.

Answer: b

Diff: E

Net working capital may be defined as current assets minus current
liabilities. This also defines the current ratio.
a. True
b. False

Net working capital
2

.

Answer: b

Diff: E

Net working capital is defined as current assets divided by current
liabilities.

a. True
b. False

Working capital
3

.

An increase in a current asset account must
corresponding increase in a liability account.

Answer: b
be

Diff: E

accompanied

by

a

a. True
b. False
Working capital policy
4

.

Answer: a

Diff: E

Determination of a firm's investment in net operating working capital
and how that investment is financed are elements of working capital
policy.
a. True
b. False

Goal of cash management
5

.

Answer: a

Diff: E

Cash is often referred to as a "non-earning" asset. Thus, one goal of
cash management is to minimize the amount of cash necessary to conduct
business.
a. True
b. False

Chapter 22 - Page 1


Motives for holding cash
6

.

Answer: a

Diff: E

Firms hold cash balances in order to complete transactions that are
necessary in business operations and as compensation to banks for
providing loans and services.
a. True
b. False

Cash budget
7

.

Answer: a

Diff: E

A firm's peak borrowing needs will probably be overstated if it bases
its monthly cash budget on uniform cash receipts and disbursements, but
actual receipts are concentrated at the beginning of each month.
a. True
b. False

Cash budget
8

.

Answer: a

Diff: E

Shorter-term cash budgets, in general, are used for actual cash control
while longer-term budgets are used primarily for planning purposes.
a. True
b. False

Float
9

.

Answer: a

Diff: E

For a firm that makes heavy use of float, being able to forecast its
collections and disbursement check clearings is essential.
a. True
b. False

Lockbox
10

.

Answer: a

Diff: E

Lockbox arrangements are one way for a firm to speed up its collection
of payments from customers.
a. True
b. False

Receivables balance
11

.

Answer: b

Diff: E

Since receivables and payables both result from sales transactions, a
firm with a high receivables-to-sales ratio will also have a high
payables-to-sales ratio.
a. True
b. False

Chapter 22 - Page 2


Receivables balance
12

.

Answer: a

Diff: E

The average accounts receivables balance is determined jointly by the
volume of credit sales and the days sales outstanding.
a. True
b. False

Receivables aging
13

.

Answer: b

Diff: E

If a firm has a large percentage of accounts over 30 days old, it is a
sign that the firm's receivables management needs to be reviewed and
improved.
a. True
b. False

Monitoring receivables
14

.

Answer: a

Diff: E

The aging schedule is a commonly used method of monitoring receivables.
a. True
b. False

Credit policy
15

.

Answer: a

Diff: E

The four major elements in a firm's credit policy are (1) credit
standards, (2) discounts offered, (3) credit period, and (4) collection
policy.
a. True
b. False

Cash discounts
16

.

Answer: b

Diff: E

If you receive some goods on April 1 with the following terms; 3/20, net
30, June 1 dating, it means that you will receive a 3 percent discount
if the bill is paid on or before June 20 and that the full amount must
be paid 30 days after receipt of the goods.
a. True
b. False

Trade discounts
17

.

Answer: b

Diff: E

Offering trade credit discounts is costly to a firm and as a result,
firms that offer trade discounts are usually those that are performing
poorly and need cash quickly.
a. True
b. False

Chapter 22 - Page 3


Change in credit policy
18

.

Answer: a

Diff: E

A firm changes its credit policy from 2/10, net 30, to 3/10, net 30. The
change is meant to meet competition, so no increase in sales is
expected. Average accounts receivable will probably decline as a result
of this change.
a. True
b. False

Goal of inventory management
19

.

Answer: b

Diff: E

The central goal of inventory management is to provide sufficient
incentives to ensure that the firm never suffers a stock-out (i.e., runs
out of an inventory item).
a. True
b. False

Goal of inventory management

20

.

Answer: a

Diff: E

The principal goal of most inventory management systems is to balance
the costs of ordering, shipping, and receiving goods with the cost of
carrying those goods, while simultaneously meeting the firm's policy
with respect to avoiding running short of stock and disrupting
production schedules.
a. True
b. False

Inventory management interaction
21

.

Answer: b

Diff: E

Inventory management is largely self-contained, that is, only minimum
coordination among other departments such as sales, purchasing, and
production is required for successful inventory management.
a. True
b. False

Working capital financing
22

.

Answer: a

Diff: E

Although short-term interest rates have historically averaged less than
long-term rates, the heavy use of short-term debt is considered to be an
aggressive working capital financing strategy because of the inherent
risks of using short-term financing.
a. True
b. False

Chapter 22 - Page 4


Permanent working capital
23

.

Answer: a

Diff: E

Permanent net operating working capital reflects the fact that net

operating working capital does not shrink to zero even when business is
at a seasonal or cyclical low. Thus, permanent net operating working
capital represents a minimum level of net operating working capital the
firm must finance.
a. True
b. False

Conservative financing approach
24

.

Answer: a

Diff: E

A conservative financing approach to working capital will result in all
permanent net operating working capital being financed using long-term
securities.
a. True
b. False

Accruals
25

.

Answer: a

Diff: E

Accruals are "free" financing in the sense that no explicit interest is
paid on accruals.
a. True
b. False

Accruals
Answer: a Diff: E
26
.
Accruals are “spontaneous,” but, unfortunately, due to law and economic
forces, firms have little control over the level of these accounts.
a. True
b. False
Accruals
27

.

Answer: b

Diff: E

The fact that no explicit interest cost is paid on accruals, and that
the firm can exercise considerable control over their level, makes
accruals an attractive source of additional funding.
a. True
b. False

Trade credit

28

.

Answer: b

Diff: E

If a firm is offered credit terms of 2/10, net 30, it is in the firm's
financial interest to pay as early as possible during the discount
period.
a. True
b. False

Chapter 22 - Page 5


Trade credit
29

.

Answer: b

Diff: E

Trade credit can be separated into two components: free trade credit,
which involves credit received after the discount period ends, and
costly trade credit, which is the cost of discounts not taken.
a. True

b. False

Trade credit
30

.

Answer: a

Diff: E

As a rule, managers should try to always use the free component of trade
credit but should use the costly component only after comparing its
costs to the costs of similar credit from other sources.
a. True
b. False

Trade credit
31

.

Answer: a

Diff: E

Trade credit is an inexpensive source of short-term financing if no
discounts are offered.
a. True
b. False

Trade credit
32

.

Answer: a

Diff: E

When deciding whether or not to take a trade discount, the cost of
borrowing funds should be compared to the cost of trade credit to
determine if the cash discount should be taken.
a. True
b. False

Cost of trade credit
33

.

Answer: a

Diff: E

The calculated cost of trade credit is reduced by paying late.
a. True
b. False

Cost of trade credit

34

.

Answer: a

Diff: E

The calculated cost of trade credit for a firm that buys on terms of
2/10, net 30, is lower (other things held constant) if the firm pays in
40 days than if it pays in 30 days.
a. True
b. False

Chapter 22 - Page 6


Cost of trade credit
35

.

Answer: a

Diff: E

One of the disadvantages of not taking trade credit discounts when
offered is that the firm's investment in accounts payable rises.
a. True
b. False

Net trade credit
36

.

Answer: b

Diff: E

A firm is said to be extending net trade credit when its accounts
receivable are less than its accounts payable.
a. True
b. False

Net trade credit
37

.

Answer: a

Diff: E

When a firm has accounts payable that are greater than the level of its
receivables, the firm is actually receiving net trade credit.
a. True
b. False

Stretching accounts payable

38

.

"Stretching" accounts
financing technique.

Answer: b
payable

is

a

widely

accepted

and

Diff: E
costless

a. True
b. False
Short-term financing
39

.

Answer: a

Diff: E

Short-term financing may be riskier than long-term financing since,
during periods of tight credit, the firm may not be able to rollover
(renew) its debt.
a. True
b. False

Short-term financing
40

.

Answer: a

Diff: E

One of the advantages of short-term debt financing is that firms can
expand or contract their short-term credit more easily than their longterm credit.
a. True
b. False

Chapter 22 - Page 7


Short-term financing
41

.

Answer: a

Diff: E

Short-term loans generally are obtained faster than long-term loans
because when lenders consider long-term loans they insist on a more
thorough evaluation of the borrower's financial health and because the
loan agreement is more complex.
a. True
b. False

Bank loans
42

.

Answer: b

Diff: E

A line of credit and a revolving credit agreement are similar except
that a line of credit creates a legal obligation for the bank.
a. True
b. False

Bank loans
43

.

Answer: a

Diff: E

The maturity of most bank loans is short-term. Bank to business loans
are frequently 90-day notes which are often rolled over, or renewed, at
the end of their maturity.
a. True
b. False

Promissory note
44

.

Answer: b

Diff: E

A promissory note is the document signed when a bank loan is executed
and it specifies financial aspects of the loan. The separate indenture
note will specify items such as collateral and other terms and
conditions.
a. True
b. False

Line of credit
45

.

Answer: a

Diff: E

A line of credit can be either a formal or informal agreement between
borrower and bank regarding the maximum amount of credit the bank will
extend to the borrower subject to certain conditions.
a. True
b. False

Revolving credit and risk
46

.

Answer: a

Diff: E

Under a revolving credit agreement the risk to the firm of being unable
to obtain funds when needed is lower than with a line of credit.
a. True
b. False

Chapter 22 - Page 8

Medium:
Cash and capital budgets
47

.

Answer: b

Diff: M

The cash budget and the capital budget are planned separately, and
although they are both important to the firm, they are independent of
each other.
a. True
b. False

Cash budget and depreciation
48

.

Answer: b

Diff: M

Since depreciation is a non-cash charge it does not appear nor have an
effect on the cash budget.
a. True
b. False

Seasonal patterns and cash
49

.

Answer: b

Diff: M

The target cash balance is set optimally such that it need not be
adjusted for seasonal patterns and unanticipated fluctuations although
it is changed to reflect long-term changes in the firm's operations.
a. True
b. False

Synchronization of cash flows
50

.

Answer: a

Diff: M

Synchronization of cash flows is an important cash management technique
and
effective
synchronization
can
actually

increase
a
firm's
profitability.
a. True
b. False

Float
51

.

Answer: b

Diff: M

Collections float offsets disbursement float. If a firm's collections
float is greater than its disbursement float then a firm is said to
operate with positive net float.
a. True
b. False

Float
52

.

Answer: b

Diff: M

A lockbox plan is one method of speeding up the check-clearing process
for customer payments and decreasing the firm's net float position.
a. True
b. False

Chapter 22 - Page 9


Lockbox
53

.

Answer: b

Diff: M

A firm has a daily average collection of checks equal to $250,000. It
takes the firm approximately 4 days to convert the funds into usable
cash. Assume (1) a lockbox system could be employed which would reduce
the cash conversion procedure to 2 ½ days and (2) the firm could invest
any additional cash received at 6 percent after taxes.
The lockbox
system would be a good buy if it costs only $23,000 annually.
a. True
b. False

Receivables and growth
54

.

Answer: b

Diff: M

A firm which makes 90 percent of its sales on credit and 10 percent for
cash is currently growing at a rate of 10 percent annually. If the firm
maintains stable growth it will also be able to maintain its accounts
receivable at its current level, since the 10 percent cash sales can be
used to manage the 10 percent growth rate.
a. True
b. False

Receivables and growth
55

.

Answer: a

Diff: M

In managing a firm's accounts receivable it is possible to increase
credit sales per day yet still keep accounts receivable fairly steady if
the firm can shorten the length of its collection period.
a. True
b. False

Collection policy
56

.

Answer: b

Diff: M

A firm's collection policy and the procedures it follows to collect
accounts receivable play an important role in keeping its deferrables
period short, although too strict a collection policy can result in
outright losses due to non-payment.
a. True
b. False

Collection policy
57

.

Answer: a

Diff: M

Changes in a firm's collection policy can affect sales, working capital
and even additional funds needed.
a. True
b. False

Chapter 22 - Page 10


Cash versus credit sales
58

.

In part because money has time value, cash
profitable and more valuable than credit sales.

Answer: b
sales

are

Diff: M

always

more

a. True
b. False
Days sales outstanding
59

.

Answer: a

Diff: M

If a firm's sales and those of its customers are closely correlated with
economic conditions, it is certainly possible for a firm's total
investment in accounts receivable to decrease while its days sales
outstanding increases.
a. True
b. False

Extending the credit period
60

.

Answer: a

Diff: M

Generally, the longer the normal inventory holding period of a customer
the longer the credit period. One effect of extending the credit period
to match the customer's merchandise holding period is to increase the
deferrables period which actually serves to shorten the customer's cash
conversion cycle.
a. True
b. False

DSO and past due accounts
61

.

Answer: b

Diff: M

If a firm's terms are 2/10, net 30 days, and its DSO is 28 days, we can
be certain that the credit department is functioning efficiently and the
percentage of past due accounts is minimal.
a. True
b. False

Aging schedule and credit policy
62

.

Answer: b

Diff: M

If your firm's DSO or aging schedule deteriorates from the first quarter
of the year to the second quarter, this is a clear indication that your
firm's credit policy has weakened.
a. True
b. False

Maturity matching
63

.

Answer: a

Diff: M

Uncertainty about the exact lives of assets prevents precise maturity
matching in an ex post (i.e., after the fact) sense even though it is
possible to maturity match on an expected basis.
a. True
b. False
Chapter 22 - Page 11


Maturity matching
64

.

Answer: b

Diff: M

The maturity matching or "self-liquidating" approach involves the
financing of permanent net operating working capital with combinations
of long-term capital and short-term capital depending on the level of
interest rates. When short-term rates are high, short-term assets will
be financed with long-term debt to reduce cost and risk.
a. True
b. False

Aggressive financing approach
65

.

Answer: a

Diff: M

A firm adopting an aggressive working capital financing approach is more
sensitive to unexpected changes in the term structure of interest rates
than is a firm with a conservative financing policy.
a. True
b. False

Aggressive financing approach
66

.

Answer: b

Diff: M

A firm that employs an aggressive working capital financing policy
stands to increase profitability when the yield curve changes from
upward sloping to downward sloping.
a. True
b. False

Risk and short-term financing
67

.

Answer: a

Diff: M

The risk to the firm of borrowing using short-term credit is usually
greater than with long-term debt.
Added risk stems from greater
variability of interest costs on short-term debt. Even if its long-term
prospects are good, the firm's lender may not renew a short-term loan if
the firm is even only temporarily unable to repay it.
a. True
b. False

Short-term financing
68

.

Answer: b

Diff: M

Long-term loan agreements always contain provisions, or covenants, which
constrain the firm's future actions. Short-term credit agreements are

just as restrictive in order to protect the interests of the lender.
a. True
b. False

Chapter 22 - Page 12


Short-term financing
69

.

Answer: a

Diff: M

A firm constructing a new manufacturing plant and financing it with
short-term loans that are scheduled to be converted to first mortgage
bonds when the plant is completed, would want to separate the
construction loan from other current liabilities associated with working
capital management.
a. True
b. False

Trade credit
70

.

Answer: b

Diff: M

If a firm fails to take trade credit discounts it may cost the firm
money, but generally such a policy has a negligible effect on the firm's
income statement and no effect on the firm's balance sheet.
a. True
b. False

Stretching accounts payable
71

.

Answer: a

Diff: M

If a firm is involuntarily "stretching" its accounts payable then this
is one sign that it is undercapitalized, that is, that it needs more
working capital for operations.
a. True
b. False

Stretching accounts payable
72

.

Answer: b

Diff: M

A firm that "stretches" its accounts payable rather than paying on net
terms is actually increasing its calculated cost of credit given that it
already does not take discounts when offered, other things held
constant.
a. True
b. False

Stretching accounts payable
73

.

Answer: b

Diff: M

If one of your firm's customers is "stretching" its accounts payable,
this may be a nuisance but does not represent a real financial cost to
your firm as long as the firm periodically pays off its entire balance.
a. True
b. False

Chapter 22 - Page 13


Prime rate
74

.

Answer: b

Diff: M

The prime rate charged by big money center banks can vary greatly (for
example, as much as 2 to 4 percentage points) across banks due to banks'
ability to differentiate themselves and because particular banks develop
particular clienteles, such as mainly making loans to small firms.
a. True
b. False

Revolving credit agreement
75

.

Answer: a

Diff: M

A revolving credit agreement is a formal line of credit usually used by
large firms.
The firm will pay a fee on the unused balance of the
committed funds to compensate the bank for the commitment to extend
those funds.
a. True
b. False

Multiple Choice: Conceptual
Easy:
Working capital
76

.

Other things held constant,
increase in working capital?

Answer: c
which

of

the

following

will

Diff: E
cause

an

a.
b.
c.

d.

Cash is used to buy marketable securities.
A cash dividend is declared and paid.
Merchandise is sold at a profit, but the sale is on credit.
Long-term bonds are retired with the proceeds of a preferred stock
issue.
e. Missing inventory is written off against retained earnings.
Cash conversion cycle
77

.

Answer: b

Diff: E

Helena Furnishings wants to sharply reduce its cash conversion cycle.
Which of the following steps would reduce its cash conversion cycle?
a. The company increases its average inventory without increasing its
sales.
b. The company reduces its DSO.
c. The company starts paying its bills sooner, which reduces its average
accounts payable without reducing its sales.
d. Statements a and b are correct.
e. All of the statements above are correct.

Chapter 22 - Page 14

Cash budget
78

.

Payments lag.
Payment for plant construction.
Cumulative cash.
Statements a and c are correct.
All of the statements above are correct.

Cash budget
.

Diff: E

Which of the following is typically part of the cash budget?
a.
b.
c.
d.
e.

79

Answer: e

Answer: a

Diff: E

Which of the following statements concerning the cash budget is correct?
a. Depreciation expense is not explicitly included, but depreciation
effects are implicitly included in estimated tax payments.
b. Cash budgets do not include financial expenses such as interest and
dividend payments.
c. Cash budgets do not include cash inflows from long-term sources such
as bond issues.
d. Statements a and b are correct.
e. Statements a and c are correct.

Cash budget
80

.

Its monthly depreciation expense.
Its cash proceeds from selling one of its divisions.
Interest paid on its bank loans.
Statements b and c are correct.
All of the statements above are correct.

Marketable securities
.

Diff: E

Which of the following items should a company explicitly include in its
monthly cash budget?
a.

b.
c.
d.
e.

81

Answer: d

Answer: a

Diff: E

Which of the following is not a situation that might lead a firm to hold
marketable securities?
a. The firm has purchased a fixed asset that will require a large writeoff of depreciable expense.
b. The firm must meet a known financial commitment, such as financing an
ongoing construction project.
c. The firm must finance seasonal operations.
d. The firm has just sold long-term securities and has not yet invested
the proceeds in earning assets.
e. None of the statements above is correct.
(All of the situations
might lead the firm to hold marketable securities.)

Chapter 22 - Page 15


Monitoring receivables
82

.

Answer: b

Analyzing days sales outstanding (DSO) and the aging schedule are two
common methods for monitoring receivables.
However, they can provide
erroneous signals to credit managers when
a.
b.
c.
d.
e.

Customers’ payments patterns are changing.
Sales fluctuate seasonally.
Some customers take the discount and others do not.
Sales are relatively constant, either seasonally or cyclically.
None of the statements above is correct.

Credit policy
83

.

Answer: e

Credit period.
Collection policy.

Credit standards.
Cash discounts.
All of the statements above are credit policy variables.

Credit policy
.

Answer: d

It normally stimulates sales.
To meet competitive pressures.
To increase the firm’s deferral period for payables.
Statements a and b are correct.
All of the statements above are correct.

Inventory management
.

Diff: E

If easing a firm’s credit policy lengthens the collection period and
results in a worsening of the aging schedule, then why do firms take
such actions?
a.
b.
c.
d.
e.

85

Diff: E

Which of the following is not commonly regarded as being a credit policy
variable?
a.
b.
c.
d.
e.

84

Diff: E

Which of the
management?
a.
b.
c.
d.
e.

Answer: e
following

might

be

attributed

to

High inventory turnover ratio.
Low incidence of production schedule disruptions.
High total assets turnover.
Statements a and c are correct.
All of the statements above are correct.

Chapter 22 - Page 16

efficient

Diff: E

inventory


Working capital financing policy
86

.

Firms generally choose to finance
capital with short-term debt because

temporary

net

Answer: a

Diff: E

operating

working

a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than
long-term interest rates.
c. A firm that borrows heavily long-term is more apt to be unable to
repay the debt than a firm that borrows heavily short-term.
d. The yield curve has traditionally been downward sloping.
e. Sales remain constant over the year, and financing requirements also
remain constant.
Commercial paper
87

.

Which of the
incorrect?

Answer: d
following

statements

concerning

commercial

Diff: E

paper

is

a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate below the prime
rate.
c. Commercial paper is sold to money market mutual funds, as well as to
other financial institutions and nonfinancial corporations.
d. Commercial paper can be issued by virtually any firm so long as it is
willing to pay the going interest rate.
e. Commercial paper is a type of unsecured promissory note issued by
large, strong firms.
Working capital financing
88

.

Answer: e

Diff: E

Which of the following statements is most correct?
a. Trade credit is provided to a business only when purchases are made.

b. Commercial paper is a form of short-term financing that is primarily
used by large, financially stable companies.
c. Short-term debt, while often cheaper than long-term debt, exposes a
firm to the potential problems associated with rolling over loans.
d. Statements b and c are correct.
e. All of the statements above are correct.

Chapter 22 - Page 17


Working capital financing
89

.

Answer: a

Diff: E

Which of the following statements is incorrect?
a. Commercial paper can be issued by virtually any firm so long as it is
willing to pay the going interest rate.
b. Accruals are “free” in the sense that no explicit interest is paid on
these funds.
c. A conservative approach to working capital will result in all
permanent assets being financed using long-term securities.
d. The risk to the firm of borrowing with short-term credit is usually
greater than with long-term debt. Added risk can stem from greater
variability of interest costs on short-term debt.
e. Bank loans have a lower interest rate than commercial paper.

Cash management
90

.

Answer: a

Diff: E

Which of the following statements is most correct?
a. A cash management system which minimizes collections float and
maximizes disbursement float is better than one with higher
collections float and lower disbursement float.
b. A cash management system which maximizes collections float and
minimizes disbursement float is better than one with lower
collections float and higher disbursement float.
c. The use of a lockbox is designed to minimize cash theft losses. If
the cost of the lockbox is less than theft losses saved, then the
lockbox should be installed.
d. Other things held constant, a firm will need an identical line of
credit if it can arrange to pay its bills by the 5th of each month
than if its bills come due uniformly during the month.
e. The statements above are all false.

Cash management
91

.

Answer: e

Diff: E

Which of the following statements is most correct?
a. A good cash management system would minimize disbursement float and
maximize collections float.
b. If a firm begins to use a well-designed lockbox system, this will
reduce its customers' net float.
c. In the early 1980's, the prime interest rate hit a high of 21
percent. In 1995 the prime rate was considerably lower. That sharp
interest rate decline has increased firms' concerns about the
efficiency of their cash management programs.
d. If a firm can get its customers to permit it to pay by wire transfers
rather than having to write checks, this will increase its net float
and thus reduce its required cash balances.
e. A firm which has such an efficient cash management system that it has
positive net float can have a negative checkbook balance at most
times and still not have its checks bounce.

Chapter 22 - Page 18


Lockbox
92

.

Answer: d

Diff: E

A lockbox plan is
a.
b.
c.
d.
e.

A method for safe-keeping of marketable securities.
Used to identify inventory safety stocks.
A system for slowing down the collection of checks written by a firm.
A system for speeding up a firm's collections of checks received.
Not described by any of the statements above.

Medium:
Cash conversion cycle
93

.

Maintain the level of receivables as sales decrease.
Buy more raw materials to take advantage of price breaks.
Take discounts when offered.
Forgo discounts that are currently being taken.
Offer a longer deferral period to customers.

Cash conversion cycle
.

Diff: M

Ignoring cost and other effects on the firm, which of the following
measures would tend to reduce the cash conversion cycle?
a.
b.
c.
d.
e.

94

Answer: d

Answer: d

Diff: M

Which of the following actions are likely to reduce the length of a
company’s cash conversion cycle?
a. Adopting a new inventory system that reduces the inventory conversion
period.
b. Reducing the average days sales outstanding (DSO) on its accounts
receivable.
c. Reducing the amount of time the company takes to pay its suppliers.
d. Statements a and b are correct.
e. All of the statements above are correct.

Chapter 22 - Page 19

Cash balances
95

.

Answer: c

Diff: M

Which of the following statements is most correct?
a. The
cash
balances
of
most
firms
consist
of
transactions,
compensating, and precautionary balances. The total desired cash
balance can be determined by calculating the amount needed for each
purpose and then summing them together.
b. The easier a firm’s access to borrowed funds, the higher its
precautionary balances will be in order to protect against sudden
increases in interest rates.
c. For some firms holding highly liquid marketable securities is a
substitute for holding cash, because the marketable securities
accomplish the same objective as cash.
d. All companies hold the same amount of funds for a transaction

balance.
e. None of the statements above is correct.

Cash budget
96

.

Answer: e

Diff: M

Which of the following statements is most correct?
a. Shorter-term cash budgets, in general, are used primarily for
planning purposes, while longer-term budgets are used for actual cash
control.
b. The cash budget and the capital budget are planned separately and
although they are both important to the firm, they are independent of
each other.
c. Since depreciation is a non-cash charge, it does not appear on nor
have an effect on the cash budget.
d. The target cash balance is set optimally such that it need not be
adjusted for seasonal patterns and unanticipated fluctuations in
receipts, although it is changed to reflect long-term changes in the
firm’s operations.
e. The typical actual cash budget will reflect interest on loans and
income from investment of surplus cash. These numbers are expected
values and actual results might vary from budgeted results.

Marketable securities portfolio

97

.

Answer: d

Diff: M

Which of the following statement completions is most correct? If the
yield curve is upward sloping, then a firm’s marketable securities
portfolio, assumed to be held for liquidity purposes, should be
a.
b.
c.
d.
e.

Weighted toward long-term securities because they pay higher rates.
Weighted toward short-term securities because they pay higher rates.
Weighted toward U.S. Treasury securities to avoid interest rate risk.
Weighted toward short-term securities to avoid interest rate risk.
Balanced between long- and short-term securities to minimize the
effects of either an upward or a downward trend in interest rates.

Chapter 22 - Page 20


Compensating balances
98

.

Answer: c

Diff: M

Which of the following statements is most correct?
a. Compensating balance requirements apply only to businesses, not to
individuals.
b. Compensating balances are essentially costless to most firms, because
those firms would normally have such funds on hand to meet
transactions needs anyway.
c. If the required compensating balance is larger than the transactions
balance the firm would ordinarily hold, then the effective cost of
any loan requiring such a balance is increased.
d. Banks are prohibited from earning interest on the funds they force
businesses to keep as compensating balances.
e. None of the statements above is correct.

Receivables management
99

.

Answer: b

Diff: M

Which of the following statements is most correct?
a. A firm that makes 90 percent of its sales on credit and 10 percent

for cash is growing at a rate of 10 percent annually. If the firm
maintains stable growth it will also be able to maintain its accounts
receivable at its current level, since the 10 percent cash sales can
be used to manage the 10 percent growth rate.
b. In managing a firm’s accounts receivable it is possible to increase
credit sales per day yet still keep accounts receivable fairly steady
if the firm can shorten the length of its collection period.
c. If a firm has a large percentage of accounts over 30 days old, it is
a sign that the firm’s receivables management needs to be reviewed
and improved.
d. Since receivables and payables both result from sales transactions, a
firm with a high receivables-to-sales ratio should also have a high
payables-to-sales ratio.
e. None of the statements above is correct.

DSO and aging schedule
100

.

Answer: c

Diff: M

Which of the following statements is most correct?
a. If a firm’s volume of credit sales declines then its DSO will also
decline.
b. If a firm changes its credit terms from 1/20, net 40 days, to 2/10,
net 60 days, the impact on sales can’t be determined because the
increase in the discount is offset by the longer net terms, which

tends to reduce sales.
c. The DSO of a firm with seasonal sales can vary. While the sales per
day figure is usually based on the total annual sales, the accounts
receivable balance will be high or low depending on the season.
d. An aging schedule is used to determine what portion of customers pay
cash and what portion buy on credit.
e. Aging schedules can be constructed from the summary data provided in
the firm’s financial statements.
Chapter 22 - Page 21


Days sales outstanding (DSO)
101

.

Answer: c

Diff: M

Which of the following statements is most correct?
a. Other things held constant, the higher a firm’s days sales
outstanding (DSO), the better its credit department.
b. If a firm that sells on terms of net 30 changes its policy and begins
offering all customers terms of 2/10, net 30 days, and if no change
in sales volume occurs, then the firm’s DSO will probably increase.
c. If a firm sells on terms of 2/10, net 30 days, and its DSO is 30
days, then its aging schedule would probably show some past due
accounts.
d. Statements a and c are correct.

e. None of the statements above is correct.

Working capital policy
102

.

Answer: d

Diff: M

Which of the following statements is incorrect about working capital
policy?
a. A company may hold a relatively large amount of cash if it
anticipates uncertain sales levels in the coming year.
b. Credit policy has an impact on working capital since it has the
potential to influence sales levels and the speed with which cash is
collected.
c. The cash budget is useful in determining future financing needs.
d. Holding minimal levels of inventory can reduce inventory carrying
costs and cannot lead to any adverse effects on profitability.
e. Managing working capital levels is important to the financial staff
since it influences financing decisions and overall profitability of
the firm.

Miscellaneous concepts
103

.

Answer: e

Diff: M

Which of the following statements is most correct?
a. Depreciation is included in the estimate of cash flows (Cash flow =
Net income + Depreciation), so depreciation is set forth on a
separate line in the cash budget.
b. If cash inflows and cash outflows occur on a regular basis, such as
the situation in which inflows from collections occur in equal
amounts each day and most payments are made regularly on the 10th of
each month, then it is not necessary to use a daily cash budget. A
cash budget prepared at the end of the month will suffice.
c. Sound working capital policy is designed to maximize the time between
cash expenditures on materials and the collection of cash on sales.
d. Statements b and c are correct.
e. None of the statements above is correct.

Chapter 22 - Page 22


Working capital financing policy
104

.

Answer: c

Diff: M

Ski Lifts Inc. is a highly seasonal business.
The following summary
balance sheet provides data for peak and off-peak seasons (in thousands
of dollars):
Cash
Marketable securities
Accounts receivable
Inventories
Net fixed assets
Total assets

Peak
$ 50
0
40
100
500
$690

Off-peak
$ 30
20
20
50
500
$620

Spontaneous liabilities
Short-term debt
Long-term debt

Common equity
Total claims

$ 30
50
300
310
$690

$ 10
0
300
310
$620

From this data we may conclude that
a. Ski Lifts has a working capital financing policy of exactly matching
asset and liability maturities.
b. Ski Lifts’ working capital financing policy is relatively aggressive;
that is, the company finances some of its permanent assets with
short-term discretionary debt.
c. Ski Lifts follows a relatively conservative approach to working
capital financing; that is, some of its short-term needs are met by
permanent capital.
d. Without income statement data, we cannot determine the aggressiveness
or conservatism of the company’s working capital financing policy.
e. Statements a and c are correct.
Working capital financing policy
105

.

Answer: b

Diff: M

Which of the following statements is most correct?
a. Net working capital may be defined as current assets minus current
liabilities.
Any increase in the current ratio will automatically
lead to an increase in net working capital.
b. Although short-term interest rates have historically averaged less
than long-term rates, the heavy use of short-term debt is considered
to be an aggressive strategy because of the inherent risks of using
short-term financing.
c. If a company follows a policy of “matching maturities,” this means
that it matches its use of common stock with its use of long-term
debt as opposed to short-term debt.
d. All of the statements above are correct.
e. None of the statements above is correct.

Chapter 22 - Page 23


Working capital financing policy
106

.

Answer: c

Diff: M

Which of the following statements is most correct?
a. Accruals are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances all
of its fixed assets with long-term capital and part of its permanent
net operating working capital with short-term, nonspontaneous credit.
c. If a company receives trade credit under the terms 2/10, net 30 days,
this implies the company has 10 days of free trade credit.
d. Statements a and b are correct.
e. None of the answers above is correct.

Short-term financing
107

.

Answer: a

Diff: M

Which of the following statements is most correct?
a. Under normal conditions, a firm’s expected ROE would probably be
higher if it financed with short-term rather than with long-term
debt, but the use of short-term debt would probably increase the
firm’s risk.
b. Conservative firms generally use no short-term debt and thus have
zero current liabilities.
c. A short-term loan can usually be obtained more quickly than a longterm loan, but the cost of short-term debt is likely to be higher

than that of long-term debt.
d. If a firm that can borrow from its bank buys on terms of 2/10, net 30
days, and if it must pay by Day 30 or else be cut off, then we would
expect to see zero accounts payable on its balance sheet.
e. If one of your firm’s customers is “stretching” its accounts payable,
this may be a nuisance but does not represent a real financial cost
to your firm as long as the firm periodically pays off its entire
balance.

Chapter 22 - Page 24


Short-term versus long-term financing
108

.

Answer: d

Diff: M

Which of the following statements is most correct?
a. Under normal conditions the shape of the yield curve implies that the
interest cost of short-term debt is greater than that of long-term
debt, although short-term debt has other advantages that make it
desirable as a financing source.
b. Flexibility is an advantage of short-term credit but this is somewhat
offset by the higher flotation costs associated with the need to
repeatedly renew short-term credit.
c. A short-term loan can usually be obtained more quickly than a longterm loan but the penalty for early repayment of a short-term loan is

significantly higher than for a long-term loan.
d. Statements about the flexibility, cost, and riskiness of short-term
versus long-term credit are dependent on the type of credit that is
actually used.
e. Short-term debt is often less costly than long-term debt and the
major reason for this is that short-term debt exposes the borrowing
firm to much less risk than long-term debt.

Cash management
109

.

Send
Have
Have
Hold
Make

payables over a wide geographic area.
widely disbursed manufacturing facilities.
a large marketable securities account to protect.
inventories at many different sites.
collections over a wide geographic area.

Float
.

Diff: M

A lockbox plan is most beneficial to firms which
a.
b.
c.
d.
e.

110

Answer: e

Answer: a

Diff: M

Which of the following statements is most correct?
a. Poor synchronization of cash flows which results in high cash
management costs can be partially offset by increasing disbursement
float and decreasing collections float.
b. The size of a firm's net float is primarily a function of its natural
cash flow synchronization and how it clears its checks.
c. Lockbox systems are used mainly for security purposes as well as to
decrease the firm's net float.
d. If a firm can speed up its collections and slow down its
disbursements, it will be able to reduce its net float.
e. A firm practicing good cash management and making use of positive net
float will bring its check book balance as close to zero as possible,
but must never generate a negative book balance.

Chapter 22 - Page 25