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Sample Questions from Chapter 15

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
2. An increase in any current asset must be accompanied by an equal increase in some current liability.
a. True
b. False
ANSWER: False
3. 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
4. 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
5. 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
6. 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
7. 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

8. 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
9. 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.
e. If a company follows a policy of matching maturities, this means that it matches its use of shortterm debt with its use of long-term debt.
ANSWER: b
10. 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
11. 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
2

12. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from
$345,000 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. $345,000
b. $307,050
c. $262,200
d. $369,150
e. $379,500
ANSWER:
a
FEEDBACK:
a.
Lower total asset range
$345,000
Upper total asset range
$410,000
Minimum total assets = FA + Min. CA = $345,000 = 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.

b.
c.
d.
e.
13. Inmoo Companys average age of accounts receivable is 68 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. 113 days
b. 76 days
c. 97 days
d. 104 days
e. 114 days
ANSWER:
c
FEEDBACK:
a. CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Deferral. Period
Age of receivables = Rec. Coll. Period =
Age of inventory = Inv. Conv. Period =
Age of payables = Pay. Def. Period =

68 days
69 days
40 days

CCC = Inv. Conv. Period + Rec. Coll. Period - Pay. Deferral.


Period =

97 days

b.
c.
d.
e.

14. 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. 15.2 days
b. 14.0 days
c. 15.7 days
d. 13.7 days
e. 14.8 days
ANSWER:
a
FEEDBACK:
a. 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

b.
c.
d.
e.
15. A firm buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 85 days.
What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?
a. 17.58%
b. 15.00%
c. 18.55%
d. 16.13%
e. 13.22%
ANSWER:
d
FEEDBACK:
a. Discount %
3% Net days
45
Discount days
15 Actual days to payment
85
Nom. % cost = Disc %/(100 - Disc %) (365/(Actual days - Disc days))
Nom. % cost = 3.09% 5.21 = 16.13%
The effective discount % is earned N times per year; the product is the nominal
annual cost rate.

b.
c.
d.
e.

16. 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 firms cash conversion cycle. Using the following information and a
365-day year, what is the firms present cash conversion cycle?
Average inventory =
Annual sales =
Annual cost of goods sold =
Average accounts receivable =
Average accounts payable =
a. 128.4 days
b. 121.5 days
c. 87.1 days
d. 114.6 days
e. 88.2 days
ANSWER:
d
FEEDBACK:
a. Avg. inventory =
Avg. receivables =
Avg. payables =

$75,000
$775,000
$465,000
$160,000
$25,000

$75,000
$160,000
$25,000

Annual sales =
Annual COGS =
Days in year =

Inv Conv Period = Inv/(COGS/365)


+ DSO = Receivables/(Sales/365)
Payables deferral = Payables/(COGS/365)
Cash Conversion Cycle (CCC)
b.
c.
d.
e.

58.9 days
75.4 days
19.6 days
114.6 days

$775,000
$465,000
365