CHAPTER 17—WORKING CAPITAL MANAGEMENT

1. Net operating working capital, defined as current assets minus the difference between current liabilities and notes
payable, is equal to the current ratio minus the quick ratio.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-1 Background on Working Capital
TOPICS:   Net operating working capital
KEYWORDS:   Bloom’s: Knowledge

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

  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-1 Background on Working Capital
TOPICS:   Net working capital
KEYWORDS:   Bloom’s: Knowledge

3. An increase in any current asset must be accompanied by an equal increase in some current liability.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-1 Background on Working Capital
TOPICS:   Working capital
KEYWORDS:   Bloom's: Comprehension

4. The three alternative current asset investment policies discussed in the text differ regarding the size of current asset
holdings.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-2 Current Assets Investment Policies
TOPICS:   Current asset investment
KEYWORDS:   Bloom’s: Knowledge

5. 
  a. True
  b. False
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Permanent current assets
KEYWORDS:   Bloom's: Comprehension

6. A conservative financing approach to working capital will result in permanent current assets and some seasonal current
assets being financed using long-term securities.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Conservative financing
KEYWORDS:   Bloom's: Comprehension

7. 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 current asset financing strategy because of the inherent risks of using short-term
financing.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Current asset financing
KEYWORDS:   Bloom's: Comprehension

8. If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen
its cash conversion cycle (CCC) and cause a deterioration in its cash position.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Comprehension

9. Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash
conversion cycle (CCC).
  a. True
  b. False

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Comprehension

10. Shorter-term cash budgets (such as a daily cash budget for the next month) are generally used for actual cash control
while longer-term cash budgets (such as a monthly cash budgets for the next year) are generally used for planning
purposes.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom’s: Knowledge

11. Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Lockbox
KEYWORDS:   Bloom’s: Knowledge

12. Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing,
and production personnel is required for successful inventory management.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-7 Inventories
TOPICS:   Inventory management
KEYWORDS:   Bloom’s: Knowledge

13. The average accounts receivables balance is a function of both the volume of credit sales and the days sales
outstanding.
  a. True
  b. False
ANSWER:   True
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POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Receivables balance
KEYWORDS:   Bloom’s: Knowledge

14. The four primary 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
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Credit policy
KEYWORDS:   Bloom’s: Knowledge

15. Changes in a firm's collection policy can affect sales, working capital, and profits.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Collection policy
KEYWORDS:   Bloom’s: Knowledge

16. Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing
poorly and have inadequate cash balances.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Taking discounts
KEYWORDS:   Bloom’s: Knowledge

17. If a firm buys on terms of 2/10, net 30, it should pay as early as possible during the discount period to lower its cost of
trade credit.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
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REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit
KEYWORDS:   Bloom's: Comprehension

18. Trade credit can be separated into two components: free trade credit, which is credit received after the discount period
ends, and costly trade credit, which is the cost of discounts not taken.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit
KEYWORDS:   Bloom’s: Knowledge

19. As a rule, managers should try to always use the free component of trade credit but should use the costly component
only if the cost of this credit is lower than the cost of credit from other sources.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit
KEYWORDS:   Bloom's: Comprehension

20. If a firm's suppliers stop offering discounts, then its use of trade credit is more likely to increase than to decrease other
things held constant.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit
KEYWORDS:   Bloom's: Comprehension

21. When deciding whether or not to take a trade discount, the cost of borrowing from a bank or other source should be
compared to the cost of trade credit to determine if the cash discount should be taken.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
TOPICS:   Trade credit
KEYWORDS:   Bloom’s: Knowledge

22. The calculated cost of trade credit can be reduced by paying late.

  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Cost of trade credit
KEYWORDS:   Bloom's: Comprehension

23. 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 plans to pay in 40 days than in 30 days.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Cost of trade credit
KEYWORDS:   Bloom's: Comprehension

24. One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things
held constant.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Cost of trade credit
KEYWORDS:   Bloom’s: Knowledge

25. "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique, which is
particularly useful when suppliers' production plants are at full capacity.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Stretching accts payables
KEYWORDS:   Bloom’s: Knowledge
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26. An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal
obligation for the bank and thus is a more reliable source of funds for the borrower than the revolving credit agreement.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-10 Bank Loans
TOPICS:   Bank loans
KEYWORDS:   Bloom’s: Knowledge

27. The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which
are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation
deteriorates, then the bank may refuse to roll over the loan.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-10 Bank Loans
TOPICS:   Bank loans
KEYWORDS:   Bloom’s: Knowledge

28. A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the
maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower
maintains its financial strength.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-10 Bank Loans
TOPICS:   Line of credit
KEYWORDS:   Bloom’s: Knowledge

29. If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when
needed is lower than if it had an informal line of credit.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-10 Bank Loans
TOPICS:   Revolving credit

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
KEYWORDS:   Bloom’s: Knowledge

30. Accruals arise automatically from a firm's operations and are "free" capital in the sense that no explicit interest must
normally be paid on accrued liabilities.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-12 Accruals (Accrued Liabilities)
TOPICS:   Accruals
KEYWORDS:   Bloom’s: Knowledge

31. Accruals are "spontaneous" funds arising automatically from a firm's operations, but unfortunately, due to law and
economic forces, firms have little control over the level of these accounts.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-12 Accruals (Accrued Liabilities)
TOPICS:   Accruals
KEYWORDS:   Bloom’s: Knowledge

32. The facts that (1) no explicit interest is paid on accruals and (2) the firm can vary the level of these accounts at will
makes them an attractive source of funding to meet the firm's working capital needs.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-12 Accruals (Accrued Liabilities)
TOPICS:   Accruals
KEYWORDS:   Bloom’s: Knowledge

33. 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 match maturities on an ex ante (expected) basis.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Maturity matching
KEYWORDS:   Bloom’s: Knowledge
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34. The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current
assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates.
When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Maturity matching
KEYWORDS:   Bloom’s: Knowledge

35. A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more
exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a
conservative financing policy.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Aggressive financing
KEYWORDS:   Bloom's: Comprehension

36. The relative profitability of a firm that employs an aggressive working capital financing policy will improve if the
yield curve changes from upward sloping to downward sloping.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Aggressive financing
KEYWORDS:   Bloom's: Comprehension

37. If the yield curve is upward sloping, then short-term debt will be cheaper than long-term debt. Thus, if a firm's CFO
expects the yield curve to continue to have an upward slope, this would tend to cause the current ratio to be relatively low,
other things held constant.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Short-term financing
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
KEYWORDS:   Bloom's: Comprehension

38. The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk
stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its
long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily
unable to repay those loans.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Short-term financing
KEYWORDS:   Bloom’s: Knowledge

39. Long-term loan agreements always contain provisions, or covenants, that constrain the firm's future actions. Short-
term credit agreements are just as restrictive in order to protect the interest of the lender.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Short-term financing
KEYWORDS:   Bloom’s: Knowledge

40. A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be
converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its
current liabilities associated with working capital when calculating net working capital.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Short-term financing
KEYWORDS:   Bloom's: Comprehension

41. The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still,
suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will
shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
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REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Comprehension

42. The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection
period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital.
Other things held constant, the shorter the CCC, the more effective the firm's working capital management.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom’s: Knowledge

43. The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal
patterns or unanticipated random fluctuations.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Seasonal cash patterns
KEYWORDS:   Bloom’s: Knowledge

44. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the
beginning of each month.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom’s: Knowledge

45. A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that
both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the
beginning of each month.
  a. True
  b. False
ANSWER:   True
POINTS:   1
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DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom’s: Knowledge

46. The cash budget and the capital budget are handled separately, and although they are both important, they are
developed completely independently of one another.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash and capital budgets
KEYWORDS:   Bloom’s: Knowledge

47. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the
depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget and depreciation
KEYWORDS:   Bloom’s: Knowledge

48. Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the
required cash balance and increase a firm's profitability.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Cash flow synchronization
KEYWORDS:   Bloom’s: Knowledge

49. On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the
checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed
which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash
generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.
  a. True
  b. False
ANSWER:   False

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
RATIONALE:   Funds generated = Days saved × Checks per day = $375,000 
Return on funds generated = Funds generated × Rate of return = $22,500 < $25,000
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Lockbox
KEYWORDS:   Bloom's: Evaluation

50. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must
also have a high payables-to-sales ratio.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Receivables balance
KEYWORDS:   Bloom's: Comprehension

51. Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are
expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain
constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held
constant.
  a. True
  b. False
ANSWER:   False
RATIONALE:   Accounts receivable will increase by 10%. That percentage increase would occur regardless of the level
of the cash sales. Even if cash sales were 90%, receivables would still increase by 10% under the
assumptions in the question.
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Receivables and growth
KEYWORDS:   Bloom's: Analysis

52. For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts
receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Receivables and growth
KEYWORDS:   Bloom's: Analysis

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
53. A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in
keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Collection policy
KEYWORDS:   Bloom’s: Knowledge

54. Because money has time value, a cash sale is always more profitable than a credit sale.
  a. True
  b. False
ANSWER:   False
RATIONALE:   Department stores, auto dealers, and many others sell on credit, using interest-bearing notes payable.
The interest rate on this credit can exceed the firm's cost of capital, making credit sales more profitable
than cash sales.
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Cash vs. credit sales
KEYWORDS:   Bloom’s: Knowledge

55. If a firm sells on terms of 2/10, net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the
30-day credit period tell us that the credit department is functioning efficiently and there are no past due accounts.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   DSO and past due accounts
KEYWORDS:   Bloom's: Evaluation

56. If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some
money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on
the balance sheet.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit

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KEYWORDS:   Bloom's: Comprehension

57. If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is
undercapitalized, i.e., that it needs more working capital to support its operations.
  a. True
  b. False
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Stretching accts payables
KEYWORDS:   Bloom's: Comprehension

58. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a
real financial cost to your firm as long as the customer periodically pays off its entire balance.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Stretching accts payables
KEYWORDS:   Bloom's: Comprehension

59. The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2
to 4 percentage points) across banks due to banks' ability to differentiate themselves and because different banks operate
in different parts of the country.
  a. True
  b. False
ANSWER:   False
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-10 Bank Loans
TOPICS:   Prime rate
KEYWORDS:   Bloom’s: Knowledge

60. A revolving credit agreement is a formal line of credit. The firm must generally 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
ANSWER:   True
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-10 Bank Loans
TOPICS:   Revolving credit

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
KEYWORDS:   Bloom’s: Knowledge

61. Other things held constant, which of the following will cause an increase in net working capital?
  a. Cash is used to buy marketable securities.
  b. A cash dividend is declared and paid.
  c. Merchandise is sold at a profit, but the sale is on credit.
  d. Long-term bonds are retired with the proceeds of a preferred stock issue.
  e. Missing inventory is written off against retained earnings.
ANSWER:   c
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-1 Background on Working Capital
TOPICS:   Net working capital
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Conceptual

62. Firms generally choose to finance temporary current assets with short-term debt because
  a. matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-
term debt is often less expensive than long-term capital.
  b. short-term interest rates have traditionally been more stable than long-term interest rates.
  c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that
borrows short term.
  d. the yield curve is normally downward sloping.
  e. short-term debt has a higher cost than equity capital.
ANSWER:   a
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Current asset financing
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

63. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?
  a. Increases average inventory without increasing sales.
  b. Take steps to reduce the DSO.
  c. Start paying its bills sooner, which would reduce the average accounts payable but not affect
sales.
  d. Sell common stock to retire long-term bonds.
  e. Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
ANSWER:   b
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Conceptual

64. A lockbox plan is

  a. used to protect cash, i.e., to keep it from being stolen.
  b. used to identify inventory safety stocks.
  c. used to slow down the collection of checks our firm writes.
  d. used to speed up the collection of checks received.
  e. used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and
less frequently by firms that receive payments as checks.
ANSWER:   d
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Lockbox
KEYWORDS:   Bloom’s: Knowledge
OTHER:   Multiple Choice: Conceptual

65. A lockbox plan is most beneficial to firms that

  a. have suppliers who operate in many different parts of the country.
  b. have widely dispersed manufacturing facilities.
  c. have a large marketable securities portfolio, and cash, to protect.
  d. receive payments in the form of currency, such as fast food restaurants, rather than in the form of
checks.
  e. have customers who operate in many different parts of the country.
ANSWER:   e
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Lockbox
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

66. Which of the following is NOT commonly regarded as being a credit policy variable?
  a. Credit period.
  b. Collection policy.
  c. Credit standards.
  d. Cash discounts.
  e. Payments deferral period.
ANSWER:   e
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Credit policy

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
KEYWORDS:   Bloom’s: Knowledge
OTHER:   Multiple Choice: Conceptual

67. Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets
and liabilities at peak and off-peak seasons (in thousands of dollars):

 
  Peak Off-Peak
Cash $50 $30
Marketable securities       0     20
Accounts receivable     40     20
Inventories    100     50
Net fixed assets  00   500
Total assets $690 $620
     
Payables and accruals $30 $10
Short-term bank debt      50      0
Long-term debt    300   300
Common equity   310   310
Total claims $690 $620
From this data we may conclude that
  a. Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities.
  b. Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its
permanent assets with short-term discretionary debt.
  c. Swim Suits follows a relatively conservative approach to current asset 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
current asset financing policy.
  e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current
asset financing policy.
ANSWER:   c
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Current asset financing
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Conceptual

68. Which of the following statements is CORRECT?

  a. Net working capital is defined as current assets minus the difference between current liabilities and notes
payable, and any increase in the current ratio automatically indicates that net working capital has increased.
  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 associated with 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. Net working capital is defined as current assets minus the difference between current liabilities and notes
payable, and any decrease in the current ratio automatically indicates that net working capital has decreased.

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  e. If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt
with its use of long-term debt.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Current asset financing
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

69. Other things held constant, which of the following would tend to reduce the cash conversion cycle?
  a. Carry a constant amount of receivables as sales decline.
  b. Place larger orders for raw materials to take advantage of price breaks.
  c. Take all discounts that are offered.
  d. Continue to take all discounts that are offered and pay on the net date.
  e. Offer longer payment terms to customers.
ANSWER:   d
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Conceptual

70. Which of the following actions would be likely to shorten the cash conversion cycle?
  a. Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20
days to 10 days.
  b. Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50.
  c. Begin to take discounts on inventory purchases; we buy on terms of 2/10, net 30.
  d. Adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw
materials to finished goods from 10 days to 20 days.
  e. Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60.
ANSWER:   a
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Conceptual

71. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?
  a. Payment lags.
  b. Payment for plant construction.
  c. Cumulative cash.

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  d. Repurchases of common stock.
  e. Writing off bad debts.
ANSWER:   e
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

72. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?
  a. Payments lags.
  b. Depreciation.
  c. Cumulative cash.
  d. Repurchases of common stock.
  e. Payment for plant construction.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

73. Which of the following statements concerning the cash budget is CORRECT?

  a. Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax
payments.
  b. Cash budgets do not include financial items such as interest and dividend payments.
  c. Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds.
  d. Changes that affect the DSO do not affect the cash budget.
  e. Capital budgeting decisions have no effect on the cash budget until projects go into operation and start
producing revenues.
ANSWER:   a
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

74. Which of the following items should a company report directly in its monthly cash budget?
  a. Its monthly depreciation expense.
  b. Cash proceeds from selling one of its divisions.
  c. Accrued interest on zero coupon bonds that it issued.

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  d. New shares issued in a stock split.
  e. New shares issued in a stock dividend.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

75. Which of the following statements is 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 developed separately, and although they are both important to the
firm, one does not affect the other.
  c. Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget.
  d. The target cash balance should be set such that it need not be adjusted for seasonal patterns and unanticipated
fluctuations in receipts, although it should be changed to reflect long-term changes in the firm's operations.
  e. The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash.
These numbers, as well as other items on the cash budget, are expected values; hence, actual results might
vary from the budgeted amounts.
ANSWER:   e
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

76. Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable
securities?
  a. The firm must make a known future payment, such as paying for a new plant that is under construction.
  b. The firm is going from its peak sales season to its slack season, so its receivables and inventories will
experience a seasonal decline.
  c. The firm is going from its slack season to its peak sales season, so its receivables and inventories will
experience seasonal increases.
  d. The firm has just sold long-term securities and has not yet invested the proceeds in operating assets.
  e. The firm just won a product liability suit one of its customers had brought against it.
ANSWER:   c
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Marketable securities
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual
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77. Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the
marketable securities held in a firm's portfolio, assumed to be held for emergencies, should
  a. consist mainly of long-term securities because they pay higher rates.
  b. consist mainly of short-term securities because they pay higher rates.
  c. consist mainly of U.S. Treasury securities to minimize interest rate risk.
  d. consist mainly of short-term securities to minimize interest rate risk.
  e. be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a
downward trend in interest rates.
ANSWER:   d
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Marketable securities
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

78. Which of the following statements is most consistent with efficient inventory management? The firm has a
  a. below-average inventory turnover ratio.
  b. low incidence of production schedule disruptions.
  c. below-average total assets turnover ratio.
  d. relatively high current ratio.
  e. relatively low DSO.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-7 Inventories
TOPICS:   Inventory management
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

79. Which of the following statements is CORRECT?

  a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually.
Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be
used to finance the 10% 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, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
  c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
  d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio
must also have a high payables-to-sales ratio.
  e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
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TOPICS:   Receivables management
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

80. Which of the following statements is 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 to 2/10, net 30, 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, and its DSO is 30 days, then the firm probably has some past due
accounts.
  d. If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its
DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower
in January than in July.
  e. If a firm changed the credit terms offered to its customers from 2/10, net 30 to 2/10, net 60, then its sales
should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the
DSO.
ANSWER:   c
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Days sales outstanding (DSO)
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

81. Which of the following statements is CORRECT?

  a. Trade credit is provided only to relatively large, strong firms.
  b. Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable
companies.
  c. Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it
exposes the borrowing firm to less risk than long-term debt.
  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 typically offered at a long-term maturity of at least five years.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Current asset financing
KEYWORDS:   Bloom’s: Knowledge
OTHER:   Multiple Choice: Conceptual

82. Which of the following statements is NOT CORRECT?

  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 management will result in most if not all permanent assets being
financed with long-term capital.
  d. The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term
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debt. This added risk stems from the greater variability of interest costs on short-term debt and possible
difficulties with rolling over short-term debt.
  e. Bank loans generally carry a higher interest rate than commercial paper.
ANSWER:   a
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Current asset financing
KEYWORDS:   Bloom’s: Knowledge
OTHER:   Multiple Choice: Conceptual

83. Which of the following statements is 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 using 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 long-term loan, but the cost of short-term debt
is normally higher than that of long-term debt.
  d. If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, 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 it will not have
an adverse financial impact on your firm if the customer periodically pays off its entire balance.
ANSWER:   a
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Short-term financing
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

84. Which of the following statements is NOT CORRECT?

  a. A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its
volume of sales, profits, and cash flows during the coming year.
  b. Credit policy has an impact on working capital because it influences both sales and the time before receivables
are collected.
  c. The cash budget is useful to help estimate future financing needs, especially the need for short-term working
capital loans.
  d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit
policy from 2/10, net 30 to net 60.
  e. Managing working capital is important because it influences financing decisions and the firm's profitability.
ANSWER:   d
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Working capital policy
KEYWORDS:   Bloom's: Comprehension

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OTHER:   Multiple Choice: Conceptual

85. Which of the following statements is CORRECT?

  a. Depreciation is included in the estimate of free cash flows (FCF = EBIT(1 − T) + Depreciation − [Capital
expenditures + ΔNOWC]), hence depreciation is set forth on a separate line in the cash budget.
  b. If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of
each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a
daily cash budget.
  c. Sound working capital policy is designed to maximize the time between cash expenditures on materials and
the collection of cash on sales.
  d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit
policy from 2/10, net 30 to net 60.
  e. If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then
its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be
lower in October than in August.
ANSWER:   b
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Working capital concepts
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

86. Which of the following statements is CORRECT?

  a. Accruals are an expensive but commonly used way to finance working capital.
  b. A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital
and all of its net working capital with short-term funds.
  c. If a company receives trade credit under terms of 2/10, net 30, this implies that the company has 10 days of
free trade credit.
  d. One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an
examination of its cash budget.
  e. If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its
current ratio will probably be relatively high.
ANSWER:   c
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  Comprehensive
TOPICS:   Working capital concepts
KEYWORDS:   Bloom's: Comprehension
OTHER:   Multiple Choice: Conceptual

87. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to
$410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working
capital financing policy, what is the most likely total of long-term debt plus equity capital?
  a. $260,642
  b. $274,360

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  c. $288,800
  d. $304,000
  e. $320,000
ANSWER:   e
RATIONALE:   Lower total asset range $320,000
Upper total asset range $410,000

Minimum total assets = FA + Min. CA = $320,000 = LT Debt + Equity 

A maturity matching policy implies that fixed assets and permanent current assets are financed with
long-term sources. This is its most likely level of long-term financing.
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   Maturity matching
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

88. Cass & Company has the following data. What is the firm's cash conversion cycle?
Inventory conversion period = 50 days
Receivables collection period = 17 days
Payables deferral period = 25 days
   
  a. 31 days
  b. 34 days
  c. 38 days
  d. 42 days
  e. 46 days
ANSWER:   d
RATIONALE:   Inventory conversion period = 50 days
Receivables collection period = 17 days
Payables deferral period = 25 days

CCC = Inv. conv. period + Rec. coll. period − Pay. def. period = 42 days
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

89. Romano Inc. has the following data. What is the firm's cash conversion cycle?
Inventory conversion period = 38 days
Receivables collection period = 19 days
Payables deferral period = 20 days
   
  a. 33 days
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  b. 37 days
  c. 41 days
  d. 45 days
  e. 49 days
ANSWER:   b
RATIONALE:   Inventory conversion period = 38 days
Receivables collection period = 19 days
Payables deferral period = 20 days

CCC = Inv. conv. period + Rec. coll. period − Pay. def. period = 37 days
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

90. Whittington Inc. has the following data. What is the firm's cash conversion cycle?
Inventory conversion period = 41 days
Receivables collection period = 31 days
Payables deferral period = 38 days
   
  a. 31 days
  b. 34 days
  c. 37 days
  d. 41 days
  e. 45 days
ANSWER:   b
RATIONALE:   Inventory conversion period = 41 days
Receivables collection period = 31 days
Payables deferral period = 38 days

CCC = Inv. conv. period + Rec. coll. period − Pay. def. period = 34 days
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

91. Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and
the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?
  a. 63 days
  b. 67 days
  c. 70 days
  d. 74 days
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  e. 78 days
ANSWER:   d
RATIONALE:   CCC = Inv. conv. period + Rec. coll. period − Pay. deferral period

Age of receivables = Rec. conv. period = 45 days

Age of inventory = Inv. conv. period = 69 days
Age of payables = Pay. def. period = 40 days

CCC = Inv. conv. period + Rec. coll. period − Pay. deferral period = 74 days
POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

92. Singal Inc. is preparing its cash budget. It expects to have sales of $30,000 in January, $35,000 in February, and
$35,000 in March. If 20% of sales are for cash, 40% are credit sales paid in the month after the sale, and another 40% are
credit sales paid 2 months after the sale, what are the expected cash receipts for March?
  a. $24,057
  b. $26,730
  c. $29,700
  d. $33,000
  e. $36,300
ANSWER:   d
RATIONALE:     Payments:
Cash 20%
Pay 2nd month 40%
Pay 3rd month 40%

         
    Collections
  Sales for Mos.   January February March
January $30,000   $6,000 $12,000 $12,000
February  35,000      7,000   14,000
March  35,000  7,000
Total collections for month:       $6,000   $19,000   $33,000

POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

93. Dyl Pickle Inc. had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days. What was
its average receivables balance, based on a 365-day year?
  a. $335,616
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  b. $352,397
  c. $370,017
  d. $388,518
  e. $407,944
ANSWER:   a
RATIONALE:   Sales $3,500,000
DSO 35 days

Receivables = (Sales per day)(DSO) = Sales/365 × DSO = $335,616

POINTS:   1
DIFFICULTY:   EASY
REFERENCES:  17-8 Accounts Receivable
TOPICS:   Accounts receivable balance
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

94. Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps
to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target
capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax
rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of
sales. What is the difference in the projected ROEs between the restricted and relaxed policies.
  a. 4.25%
  b. 4.73%
  c. 5.25%
  d. 5.78%
  e. 6.35%
ANSWER:   c
RATIONALE:   Sales $400,000        Debt ratio 50%     Interest rate 10%
Fixed assets $100,000        EBIT $35,000     Tax rate 40%
CA/Sales, restricted 15%        CA/Sales, relaxed 25%   

Restricted Relaxed
CA $  60,000 $100,000
FA  100,000  100,000
Total assets   $160,000    $200,000
     
Debt $ 80,000 $100,000
Equity   80,000  100,000
Total liab. & capital   $160,000  $200,000
     
EBIT $ 35,000 $ 35,000
Interest    8,000   10,000
EBT $ 27,000 $ 25,000
Taxes   10,800   10,000
NI   $16,200    $15,000
     
ROE 20.25% 15.00%

Difference in ROE = 5.25%   

POINTS:   1

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
DIFFICULTY:   MODERATE
REFERENCES:  17-2 Current Assets Investment Policies
TOPICS:   ROE and WC policy
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

95. Data on Shick Inc. for 2013 are shown below, along with the days sales outstanding of the firms against which it
benchmarks. The firm's new CFO believes that the company could reduce its receivables enough to reduce its DSO to the
benchmarks' average. If this were done, by how much would receivables decline? Use a 365-day year.

 
Sales $110,000
Accounts receivable $16,000
Days sales outstanding (DSO) 53.09
Benchmarks' days sales outstanding (DSO) 20.00
   
  a. $ 8,078
  b. $ 8,975
  c. $ 9,973
  d. $10,970
  e. $12,067
ANSWER:   c
RATIONALE:              Original        Benchmarks' Receivables at
Related Benchmark
  Data DSO
DSO Level
Sales $110,000     
Receivables and DSO $16,000 53.09 20.00
New receivables = DSO × (Sales/365) = $6,027
Reduction in receivables = Original receivables – New Receivables
$9,973
=
Alternative solution: (Change in DSO/Original DSO) × Original
$9,973
receivables =
   
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Days sales outstanding (DSO)
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

96. Your firm's cost of goods sold (COGS) average $2,000,000 per month, and it keeps inventory equal to 50% of its
monthly COGS on hand at all times. Using a 365-day year, what is its inventory conversion period?
  a. 11.7 days
  b. 13.0 days
  c. 14.4 days
  d. 15.2 days
  e. 16.7 days
ANSWER:   d
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
RATIONALE:   Monthly COGS = $2,000,000
Inventory/COGS = 50.0%
Annual COGS = $24,000,000
Avg. inventory = $1,000,000

Inv. conv. period = Inv/COGS per day = Inv./(Annual COGS/365) = 15.2 days
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Inventory conv. period
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

97. Data on Shin Inc for last year are shown below, along with the inventory conversion period (ICP) of the firms against
which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP
to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.
 
Cost of goods sold = $85,000
Inventory = $20,000
Inventory conversion period (ICP) = 85.88
Benchmark inventory conversion period (ICP) = 38.00
   
  a. $ 7,316
  b. $ 8,129
  c. $ 9,032
  d. $10,036
  e. $11,151
ANSWER:   e
RATIONALE:               Original         Benchmarks' ICP at
Related Benchmark
  Data ICP
ICP Level
$85,00
Cost of goods sold      
0
$20,00
Inventory and ICP 85.88 38.00
0
New inventory = ICP × (COGS/365) = $8,849
Reduction in inventories = Original Inv. − New Inv. = $11,151
Alternative solution: (Change in ICP/Original ICP) × Orig. Inv. = $11,151
   
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Inventory conv. period
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

98. Data on Wentz Inc. for last year are shown below, along with the payables deferral period (PDP) for the firms against
which it benchmarks. The firm's new CFO believes that the company could delay payments enough to increase its PDP to
the benchmarks' average. If this were done, by how much would payables increase? Use a 365-day year.

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
Cost of goods sold = $75,000
Payables = $5,000
Payables deferral period (PDP) = 24.33
Benchmark payables deferral period = 30.00
   
  a. $ 764
  b. $ 849
  c. $ 943
  d. $1,048
  e. $1,164
ANSWER:   e
RATIONALE:              Original           Benchmarks' Payables at
  Data Related PDP PDP Benchmark Level
$75,00
Cost of goods sold      
0
Inventory and PDP  $5,000 24.33 30.00
New payables = PDP × (COGS/365) = $6,164
Reduction in payables = Original Payables − New Payables = $1,164
Alternative solution: (Change in PDP/Original PDP) × Orig.
$1,164
Payables =
   
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Payables deferral period
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

99. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable
but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine
the firm's cash conversion cycle. Using the following information and a 365-day year, what is the firm's present cash
conversion cycle?
 
Average inventory = $75,000
Annual sales = $600,000
Annual cost of goods sold = $360,000
Average accounts receivable = $160,000
Average accounts payable = $25,000
   
  a. 120.6 days
  b. 126.9 days
  c. 133.6 days
  d. 140.6 days
  e. 148.0 days
ANSWER:   e
RATIONALE:   Avg. inventory = $75,000  Annual sales = $600,000
Avg. receivables = $160,000  Annual COGS = $360,000
Avg. payables = $25,000  Days in year = 365

Inv Conv. period = Inv/(COGS/365)    76.0 days

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+ DSO = Receivables/(Sales/365)    97.3 days
− Payables deferral = Payables/(COGS/365) −25.3 days
Cash conversion cycle (CCC)  148.0 days
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

100. Dewey Corporation has the following data, in thousands. Assuming a 365-day year, what is the firm's cash
conversion cycle?
 
Annual sales = $45,000
Annual cost of goods sold = $31,500
Inventory = $4,000
Accounts receivable = $2,000
Accounts payable = $2,400
   
  a. 25 days
  b. 28 days
  c. 31 days
  d. 35 days
  e. 38 days
ANSWER:   d
RATIONALE:   Annual sales $45,000
Annual cost of goods sold (COGS) $31,500
Inventory $4,000
Accounts receivable $2,000
Accounts payable $2,400
Days in year 365
Sales per day = $123.29
COGS per day = $86.30
Inv. conv. period = Inv./COGS per day = 46.35 days
Rec. coll. period = Receivables/Sales per day = 16.22 days
Pay. def. period = Accounts payable/COGS per day = 27.81 days

CCC = Inv. conv. period + Rec. coll. period − Pay. def. period = 34.76 days
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

101. Desai Inc. has the following data, in thousands. Assuming a 365-day year, what is the firm's cash conversion cycle?
 
Annual sales = $45,000
Annual cost of goods sold = $30,000
Inventory = $4,500
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
Accounts receivable = $1,800
Accounts payable = $2,500
   
  a. 28 days
  b. 32 days
  c. 35 days
  d. 39 days
  e. 43 days
ANSWER:   d
RATIONALE:   Annual sales $45,000
Annual cost of goods sold (COGS) $30,000
Inventory $4,500
Accounts receivable $1,800
Accounts payable $2,500
Days in year 365
Sales per day = $123.29
COGS per day = $82.19
Inv. conv. period = Inv./COGS per day = 54.75 days
Rec. coll. period = Receivables/Sales per day = 14.60 days
Pay. def. period = Accounts payable/COGS per day = 30.42 days

CCC = Inv. conv. period + Rec. coll. period − Pay. def. period = 38.93 days
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

102. Zervos Inc. had the following data for last year (in millions). The new CFO believes (1) that an improved inventory
management system could lower the average inventory by $4,000, (2) that improvements in the credit department could
reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby
increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs
of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?
 
  Original Revised
Annual sales: unchanged $110,000 $110,000
Cost of goods sold: unchanged $80,000 $80,000
Average inventory: lowered by $4,000 $20,000 $16,000
Average receivables: lowered by $2,000 $16,000 $14,000
Average payables: increased by $2,000 $10,000 $12,000
Days in year 365 365
     
  a. 34.0 days
  b. 37.4 days
  c. 41.2 days
  d. 45.3 days
  e. 49.8 days
ANSWER:   a

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
RATIONALE:     Original Revised
Annual sales: unchanged $110,000 $110,000
Cost of goods sold: unchanged $80,000 $80,000
Average inventory: lowered by $4,000 $20,000 $16,000
Average receivables: lowered by $2,000 $16,000 $14,000
Average payables: increased by $2,000 $10,000 $12,000
Days in year 365 365
Inv. conv. period = Inv./(COGS/365) = 91.25 days 73.00 days
DSO = Receivables/(Sales/365) = 53.09 days 46.45 days
Payables deferral = Payables/(COGS/365) = 45.63 days 54.75 days
CCC = Inv. conv. + DSO − Pay. def. period = 98.72 days 64.70 days

Change = 34.01 days

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

103. Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is
75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is
looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result in a 20%
reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales
by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on
the company's cash conversion cycle? Round to the nearest whole day.
  a. −26 days
  b. −22 days
  c. −18 days
  d. −14 days
  e. −11 days
ANSWER:   b
RATIONALE:     Original New
Annual sales $36,500,000 $32,850,000
Days in year 365 365
Sales per day $100,000 $90,000
COGS/Sales 75% 75%
COGS per day $75,000 $67,500
Inventory $9,000,000 $7,200,000
Accounts receivable $8,000,000 $6,400,000
Pay. deferral period 35 days 35 days
% reduction in inv.   20%
% reduction in rec.   20%
% reduction in sales   10%

Cash conversion cycle = Inv. conversion period + Rec. collection period − Pay. deferral period 
CCCOrig = 120.00 + 80.00 − 35.00 = 165.00 days 
CCCNew = 106.67 + 71.11 − 35.00 = 142.78 days 
CCCNew − CCCOrig = 142.78 − 165.00 = −22.22 days
POINTS:   1
DIFFICULTY:   MODERATE
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REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

104. Van Den Borsh Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000, and average
accounts receivable of $10,008,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on
credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its
suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be
lowered by $1,946,000 and accounts receivable by $1,946,000. What will be the net change in the cash conversion cycle,
assuming a 365-day year?
  a. −26.6 days
  b. −29.5 days
  c. −32.8 days
  d. −36.4 days
  e. −40.5 days
ANSWER:   e
RATIONALE:     Original New
Annual sales $50,735,000 $50,735,000
Days in year 365 365
Sales per day $139,000 $139,000
COGS/Sales 85% 85%
COGS per day $118,150 $118,150
Inventory $15,012,000 $13,062,000
Accounts receivable $10,008,000 $8,062,000
Pay. deferral period 30 days 40 days
$ reduction in inv.   $1,946,000
$ reduction in rec.   $1,946,000

Cash conversion cycle = Inv. conversion period + Rec. collection period − Pay. deferral period 
CCCOrig = 127.06 + 72.00 − 30.00 = 169.06 days 
CCCNew = 110.59 + 58.00 − 40.00 = 128.59 days 
CCCNew − CCCOrig = 128.59 − 169.06 = −40.47 days
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

105. Nogueiras Corp's budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its
customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale
and do not receive a discount. The firm has no bad debts. Purchases for next month's sales are constant at 50% of
projected sales for the next month. "Other payments," which include wages, rent, and taxes, are 25% of sales for the
current month. Construct a cash budget for a typical month and calculate the average cash gain or loss during the month.
  a. $1,092
  b. $1,150
  c. $1,210
  d. $1,271
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  e. $1,334
ANSWER:   c
RATIONALE:   Monthly sales $5,000         
Monthly purchase % 50%         
Other payments: 25%         
            
      Sales Month   Next Month      
Payment pattern:   40% 60%      
Discount   2%        
            
  Last  Current   Next 
Cash budget:      
  Month   Month      Month  
Sales       $5,000 $5,000 $5,000
             
Collections, same month's sales (% of Sales)(Sales)(1 − Discount) $1,960 
Collections (last month's sales)  3,000 
Total collections $4,960 
Purchases payments   2,500 
Other payments  1,250 
Total payments $3,750 
Net cash gain (loss)            $1,210  

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-5 The Cash Budget
TOPICS:   Cash budget
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

106. Whitmer Inc. sells to customers all over the U.S., and all receipts come in to its headquarters in New York City.  The
firm's average accounts receivable balance is $2.5 million, and they are financed by a bank loan at an 11% annual interest
rate.  The firm is considering setting up a regional lockbox system to speed up collections, and it believes this would
reduce receivables by 20%.  If the annual cost of the system is $15,000, what pre-tax net annual savings would be
realized?
  a. $29,160
  b. $32,400
  c. $36,000
  d. $40,000
  e. $44,000
ANSWER:   d
RATIONALE:   Average accounts receivable balance $2,500,000
Annual interest rate to finance A/R 11.00%
% Reduction in A/R 20.00%
Annual lockbox cost $15,000

Reduction in A/R = % reduction in A/R × Avg. A/R balance 

Reduction in A/R = 20.00% × $2,500,000 
Reduction in A/R = $500,000 

Annual int. savings = Reduction in A/R × Annual interest rate 

Annual int. savings = $500,000 × 11.00% 
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
Annual int. savings = $55,000 

Pre-tax net annual savings = Annual interest savings − Annual lockbox cost 
Pre-tax net annual savings = $55,000 − $15,000 
Pre-tax net annual savings = $40,000
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-6 Cash and Marketable Securities
TOPICS:   Lockbox
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

107. A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 60 days. What is the
nominal annual percentage cost of its non-free trade credit, based on a 365-day year?
  a. 25.09%
  b. 27.59%
  c. 30.35%
  d. 33.39%
  e. 36.73%
ANSWER:   a
RATIONALE:   Discount % 3%  Net days 45
Discount days 15  Actual days to payment 60

Nom. % cost = Disc. %/(100 − Disc. %) × (365/(Actual days − Disc. days)) 

Nom. % cost = 3.09% × 8.11 = 25.09% 

The effective discount % is earned N times per year; the product is the nominal annual cost rate.
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: nom. cost
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

108. Atlanta Cement, Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 60 days after the
invoice date. Net purchases amount to $720,000 per year. What is the nominal annual percentage cost of its non-free trade
credit, based on a 365-day year?
  a. 10.86%
  b. 12.07%
  c. 13.41%
  d. 14.90%
  e. 16.55%
ANSWER:   e
RATIONALE:   Discount % 2%  Net days 30
Discount days 15  Actual days to payment 60

Nom. % cost = Disc. %/(100 − Disc. %) × (365/(Actual days − Disc. days)) 

Nom. % cost = 2.04% × 8.11 = 16.55% 
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The effective discount % is earned N times per year; the product is the nominal annual cost rate.
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: nom. cost
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

109. Your company has been offered credit terms of 4/30, net 90 days. What will be the nominal annual percentage cost
of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)
  a. 16.05%
  b. 16.90%
  c. 17.74%
  d. 18.63%
  e. 19.56%
ANSWER:   b
RATIONALE:   Discount % 4%  Net days 90
Discount days 30  Actual days to payment 120

Nom. % cost = Disc. %/(100 − Disc. %) × (365/(Actual days − Disc. days)) = 16.90%
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: nom. cost
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

110. Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. If the
firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free
trade credit? (Assume a 365-day year.)
  a. 20.11%
  b. 21.17%
  c. 22.28%
  d. 23.45%
  e. 24.63%
ANSWER:   d
RATIONALE:   Discount % 2%  Net days 50
Discount days 15  Actual days to payment 50

EAR = [1 + Disc. %/(100 − Disc. %)][365/(Actual days − Disc. Period)] −1 = 23.45%

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: EAR cost
KEYWORDS:   Bloom's: Analysis
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OTHER:   Multiple Choice: Problem

111. A firm buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days. What is the
effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)
  a. 14.34%
  b. 15.10%
  c. 15.89%
  d. 16.69%
  e. 17.52%
ANSWER:   c
RATIONALE:   Discount % 2%  Net days 45
Discount days 8  Actual days to payment 58

EAR = [1 + Disc. %/(100 − Disc. %)][365/(Actual days − Disc. Period)] −1 = 15.89%

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: EAR cost
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

112. Buskirk Construction buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60
days after the invoice date. Net purchases amount to $450,000 per year. On average, how much "free" trade credit does
the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)
  a. $18,493
  b. $19,418
  c. $20,389
  d. $21,408
  e. $22,479
ANSWER:   a
RATIONALE:   Purchases $450,000  Net days 60
Discount % 2%  Days to payment 60
Discount days 15  Days/Year 365

Purchases/day = $450,000/365 = $1,233 

Free credit = Disc. days × Purchases/day = $18,493
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Free trade credit
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

113. Ingram Office Supplies, Inc., buys on terms of 2/15, net 50 days. It does not take discounts, and it typically pays on
time, 50 days after the invoice date. Net purchases amount to $450,000 per year. On average, what is the dollar amount of
costly trade credit (total credit − free credit) the firm receives during the year? (Assume a 365-day year, and note that
purchases are net of discounts.)
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  a. $43,151
  b. $45,308
  c. $47,574
  d. $49,952
  e. $52,450
ANSWER:   a
RATIONALE:   Purchases $450,000  Net days 50
Discount % 2%  Days to payment 50
Discount days 15  Days/Year 365

Purchases/day = $450,000/365 = $1,233 

Avg. trade credit = Average A/P = Days to payment × Net purchases/day = $61,644 
Free trade credit = Discount days × Purchases/day = $18,493 
Costly trade credit = Total credit − Free credit = $43,151 

Alternatively, Costly TC = (Days to pmt. − Disc. days) × (Purchases/day) = $43,151

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Costly trade credit
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

114. Roton Inc. purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off
the discount) are $800,000 per year. What is the maximum dollar amount of costly trade credit the firm could get,
assuming it abides by the supplier's credit terms? (Assume a 365-day year.)
  a. $53,699
  b. $56,384
  c. $59,203
  d. $62,163
  e. $65,271
ANSWER:   a
RATIONALE:   Discount 2%  Gross purchases $800,000
Discount days 15  Days in year 365
Net days 40   

Net purchases = Gross(1 − Disc. %) = $784,000 

Net per day = Net/365 = $2,148 
Total trade credit = Net days × Net per day = $85,918 
Free credit = Net per day × Discount days = $32,219 
Costly credit = Total credit − Free credit = $53,699
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Costly trade credit
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

115. Kirk Development buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total
trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-
day year, and note that purchases are net of discounts.)
  a. $ 90,411
  b. $ 94,932
  c. $ 99,678
  d. $104,662
  e. $109,895
ANSWER:   a
RATIONALE:   Purchases $550,000  Net days 60
Discount % 2%  Days to payment 60
Discount days 15  Days/Year 365

Purchases/day = $550,000/365 = $1,507 

Average trade credit = Average A/P = Days to payment × Net purchases/day = $90,411
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Total trade credit
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

116. Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of
1/10, net 20, and it currently takes the discount. One way of acquiring the needed funds would be to forgo the discount,
and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective
annual percentage cost of funds raised by this action? (Assume a 365-day year.)
  a. 10.59%
  b. 11.15%
  c. 11.74%
  d. 12.36%
  e. 13.01%
ANSWER:   e
RATIONALE:   Discount % 1%  Net days 20
Discount days 10  Actual days to payment 40

EAR = [1 + Disc. %/(100 − Disc. %)][365/(Actual days − Disc. Period)] −1 = 13.01%

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Stretching accts payable
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

117. Weiss Inc. arranged a $9,000,000 revolving credit agreement with a group of banks. The firm paid an annual
commitment fee of 0.5% of the unused balance of the loan commitment. On the used portion of the revolver, it paid 1.5%
above prime for the funds actually borrowed on a simple interest basis. The prime rate was 9% during the year. If the firm
borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the
total dollar annual cost of the revolver?
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  a. $612,750
  b. $645,000
  c. $677,250
  d. $711,113
  e. $746,668
ANSWER:   b
RATIONALE:   Total commitment $9,000,000
Fee on unused balance 0.5%
Prime rate 9.0%
Premium over prime 1.5%
Amount borrowed $6,000,000

Interest rate on borrowed funds = Prime + Premium = 10.5%

Cost of used portion = Amount borrowed × Rate = $630,000
Cost of unused portion: Unused balance × Fee = $15,000
Total annual cost of loan agreement = $645,000
   
Alternative solution:  
Rate per day = 10.5%/365 = 0.0287671%
Interest per day = (Rate per day)(Amount borrowed) = $1,726
Interest per year = (Interest per day)(365) = $630,000
Cost of unused portion: Unused balance × Fee = $15,000
Total annual cost of loan agreement = $645,000
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-10 Bank Loans
TOPICS:   Revolving credit agreement
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

118. Soenen Inc. had the following data for last year (in millions). The new CFO believes that the company could improve
its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the
benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working
capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how
much would the firm's pre-tax income have increased?
 
                  Original Benchmarks'
  Data Related CCC CCC
Sales $100,000    
Cost of goods sold $80,000    
Inventory (ICP) $20,000 91.25 38.00
Receivables (DSO) $16,000 58.40 20.00
Payables (PDP) $5,000 22.81 30.00
    126.84 28.00
  a. $1,901
  b. $2,092
  c. $2,301
  d. $2,531
  e. $2,784
ANSWER:   a
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RATIONALE:  
           Original         Benchmarks' Benchmarks'
      Data   Related CCC     CCC          Levels     
Sales $100,000      
Cost of goods sold $80,000      
Inventory = ICP(COGS/365) = $20,000   91.25 days 38.00 days $8,329
Receivables = DSO(Sales/365) = $16,000   58.40 days 20.00 days $5,479
Payables = PDP(COGS/365) = $5,000   22.81 days 30.00 days $6,575

New and old NWC  $31,000  126.84 days  28.00 days   $7,233 

Reduction in NWC = Old − New =     $23,767
Interest rate = 8%        
Savings = Interest rate × Reduction
      $1,901
in NWC =

POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

119. Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75%
of annual sales, and its receivables collection period is twice as long as its inventory conversion period. The firm buys on
terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a
365-day year. He believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must
the firm also reduce its accounts receivable to meet its goal in the reduction of its cash conversion cycle?
  a. $123,630
  b. $130,137
  c. $136,986
  d. $143,836
  e. $151,027
ANSWER:   c
RATIONALE:     Original  New 
Inventory $750,000  $647,260 
Annual sales $10,000,000  $10,000,000 
Days/year 365  365 
COGS/Sales 75.00%  75.00% 
Payables deferral period
30.00 days  30.00 days 
(PDP)
Rec. collection period (DSO) = 2 × ICP   
Cost of goods sold $7,500,000  $7,500,000 
Inv Conv. Period (ICP) 36.50 days  31.50 days 
DSO (calculated) 73.00 days  68.00 days 
Receivables (A/R) $2,000,000  $1,863,014 
CHECK on
CCC = DSO + ICP − PDP = 79.50 days  69.50 days
CCC
Decrease in CCC 10 days    
New CCC    69.50 days 

Reduction in A/R = Orig. A/R − New A/R = $136,986

POINTS:   1
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
DIFFICULTY:   CHALLENGING
REFERENCES:  17-4 The Cash Conversion Cycle
TOPICS:   Cash conversion cycle
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

120. Suppose the credit terms offered to your firm by its suppliers are 2/10, net 30 days. Your firm is not taking discounts,
but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount
and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date,
what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?
  a. 60.3%
  b. 63.5%
  c. 66.7%
  d. 70.0%
  e. 73.5%
ANSWER:   b
RATIONALE:   Discount % 2%  Net days 30
Discount days 10  Actual days to payment 25

EAR = [1 + Disc. %/(100 − Disc. %)][365/(Actual days − Disc. Period)] −1 = 63.49%

POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Trade credit: EAR cost
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

121. Aggarwal Inc. buys on terms of 2/10, net 30, and it always pays on the 30th day. The CFO calculates that the average
amount of costly trade credit carried is $375,000. What is the firm's average accounts payable balance? Assume a 365-day
year.
  a. $458,160
  b. $482,273
  c. $507,656
  d. $534,375
  e. $562,500
ANSWER:   e
RATIONALE:   Discount % 2%  Net days 30
Discount days 10  Actual days to payment 30
Costly trade credit $375,000  Years/day 365

Costly trade credit = Purchases per day × (Days credit is outstanding − Discount period)
$375,000 = Purchases per day × 20
Purchases per day = $18,750

 Free trade credit = Purchases per day × Discount period

 Free trade credit = $18,750 × 10
 Free trade credit = $187,500

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
 Total trade credit = Costly trade credit + Free trade credit
 Costly trade credit + Free trade credit
 Total trade credit = $375,000 + $187,500
 Total trade credit = $562,500
POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Accounts payable balance
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

122. Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases. The standard
industry credit terms offered by all its suppliers are 2/10, net 30 days, and the firm pays on time. The new CFO is
considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to
determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year.
The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the
expected change in net income?
  a. $32,964
  b. $34,699
  c. $36,526
  d. $38,448
  e. $40,370
ANSWER:   d
RATIONALE:   Discount % 2%  Net days 30
Discount days 10  Actual days to payment 30
Net purchases/day $11,760  Days/year 365
Annual interest rate 10.00%  Tax rate 40.00%

A/PNo disc. = Net purchases/day × Actual days to payment 

A/PNo disc. = $11,760 × 30 = $352,800 

A/PDisc. = Net purchases/day × Discount days 

A/PDisc. = $11,760 × 10 = $117,600 

Amount needed to be financed = A/PNo disc. − A/PDisc. 

Amount needed to be financed = $352,800 − $117,600 = $235,200 

Additional interest cost = Amount needed to be financed × Annual interest rate 

Additional interest cost = $235,200 × 10.00% = $23,520 

Gross purchases = (Net purchases/day × 365)/(1 − Disc. %) 

Gross purchases = $11,760 × 365/98.00% = $4,380,000 

Discounts lost = Gross purchases × Discount % 

Discounts lost = $4,380,000 × 2.00% = $87,600 

Pre-tax savings = Discounts lost − Additional interest 

Pre-tax savings = $87,600 − $23,520 = $64,080 

After-tax savings = Pre-tax savings × (1 − T) 

After-tax savings = $64,080 × 60.00% = $38,448

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  17-9 Accounts Payable (Trade Credit)
TOPICS:   Fin. stmts. and trade credit
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Problem

123. Zarruk Construction's DSO is 50 days (on a 365-day basis), accounts receivable are $100 million, and its balance
sheet shows inventory of $125 million. What is the inventory turnover ratio?
  a. 4.73
  b. 5.26
  c. 5.84
  d. 6.42
  e. 7.07
ANSWER:   c
RATIONALE:   DSO 50   Days/year 365
Receivables $100   Inventory $125

Use DSO equation to find sales: 

DSO = Receivables/(Sales/365) 
Sales = 365(Receivables)/DSO = $730 

Inventory turnover = Sales/Inventory = 5.84

POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  Comprehensive
TOPICS:   Inventory turnover and DSO
KEYWORDS:   Bloom's: Analysis
OTHER:   Multiple Choice: Problem

124. Madura Inc. wants to increase its free cash flow by $180 million during the coming year, which should result in a
higher EVA and stock price. The CFO has made these projections for the upcoming year:
∙ EBIT is projected to equal $850 million.
Gross capital expenditures are expected to total to $360 million versus depreciation of $120
∙
million, so its net capital expenditures should total $240 million.
∙ The tax rate is 40%.
There will be no changes in cash or marketable securities, nor will there be any changes in
∙
notes payable or accruals.
What increase in net operating working capital (in millions of dollars) would enable the firm to meet its target increase in
FCF?
  a. $ 72
  b. $ 90
  c. $108
  d. $130
  e. $156
ANSWER:   b
RATIONALE:   EBIT $850
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CHAPTER 17—WORKING CAPITAL MANAGEMENT
Gross capital expenditures $360
Depreciation $120
Tax rate 40%
Target increase in FCF $180

FCF = EBIT(1 − T) + Deprec. − Capex. − ΔNOWC

$180 = $510 + $120 − $360 − ΔNOWC
$180 = $270 − ΔNOWC
−$90 = −ΔNOWC
ΔNOWC = $90
POINTS:   1
DIFFICULTY:   CHALLENGING
REFERENCES:  Comprehensive
TOPICS:   Working capital, FCF
KEYWORDS:   Bloom's: Application
OTHER:   Multiple Choice: Problem

Exhibit 16.1
Zorn Corporation is deciding whether to pursue a restricted or relaxed working capital investment policy. The firm's
annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are
each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the
company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover
will be 2.2.

125. Refer to Exhibit 15.1. If the firm adopts a restricted policy, how much lower would its interest expense be than under
the relaxed policy?

  a. $ 8,418
  b. $ 8,861
  c. $ 9,327
  d. $ 9,818
  e. $10,309
ANSWER:   d
RATIONALE:   Annual sales $3,600,000
Fixed assets turnover (FATO) 4.0
Debt/TA 50.00%
Equity/TA 50.00%
EBIT $150,000
Interest rate 10.00%
Tax rate 40.00%
Total assets turnover (restricted) 2.5
Total assets turnover (relaxed) 2.2

FA turnover = Sales/Net FA
4.0 = $3,600,000/Net FA
Net FA = $900,000
   
Restricted:  
TATO = Sales/Total assets
2.5 = $3,600,000/Total assets
Total assets = $1,440,000
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Relaxed:  
TATO = Sales/Total assets
2.2 = $3,600,000/Total assets
Total assets = $1,636,364

Balance Sheets: Restricted Relaxed

Current assets $540,000 $736,364
Fixed assets     900,000     900,000
Total assets  $1,440,000  $1,636,364
     
Debt $720,000 $818,182
Equity 720,000  818,182
Total liab. & equity $1,440,000    $1,636,364
     
Interest: $72,000 $81,818
POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   WC investment policy
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Multiple Parts

126. Refer to Exhibit 16.1. What's the difference in the projected ROEs under the restricted and relaxed policies?
  a. 1.20%
  b. 1.50%
  c. 1.80%
  d. 2.16%
  e. 2.59%
ANSWER:   b
RATIONALE:     Restricted Relaxed
EBIT $150,000 $150,000
Interest  72,000  81,818
EBT $78,000 $68,182
Taxes  31,200  27,273
Net income  $46,800   $40,909
     
ROE = Net income/Equity 6.50% 5.00%

Difference in ROEs = 1.50% 

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   WC investment, ROE
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Multiple Parts

127. Refer to Exhibit 16.1. Assume now that the company believes that if it adopts a restricted policy, its sales will fall by
15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same.
In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

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CHAPTER 17—WORKING CAPITAL MANAGEMENT
  a. 2.24%
  b. 2.46%
  c. 2.70%
  d. 2.98%
  e. 3.27%
ANSWER:   a
RATIONALE:   % Change in sales −15.00%
% Change in EBIT −10.00%
   
New sales $3,060,000
New EBIT $135,000
 
Restricted:
TATO = Sales/Total assets
2.5 = $3,060,000/Total assets
Total assets = $1,224,000
 
Balance Sheet: Restricted
    
Total assets  $1,224,000 
    
Debt $612,000 
Equity     612,000 
Total liab. & equity  $1,224,000 
    
Income Statement: Restricted 
EBIT $135,000 
Interest  61,200 
EBT $73,800 
Taxes  29,520 
Net income   $44,280 
     
ROE = Net income/Equity = 7.24% Relaxed ROE: 5.00%

Difference in ROE = 2.24% 

POINTS:   1
DIFFICULTY:   MODERATE
REFERENCES:  17-3 Current Assets Financing Policies
TOPICS:   WC investment, ROE
KEYWORDS:   Bloom's: Evaluation
OTHER:   Multiple Choice: Multiple Parts

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