CH 14

Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
1. The appropriate mix of current assets is not a working capital management decision.
A) True
B) False
Ans: B
Format: True/False
2. Net working capital is important because it is a measure of liquidity and represents the
net short-term investment the firm keeps in the business.
A) True
B) False
Ans: A
Format: True/False
3. Working capital management involves making decisions regarding the use and sources
of current assets.
A) True
B) False
Ans: A
Format: True/False
4. Working capital efficiency refers to the length of time it takes for a firm to convert the
raw material to a finished product.
A) True
B) False
Ans: B
Format: True/False
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5. Liquidity is the ability of a company to convert assets—real or financial—into cash
quickly without suffering a financial loss.
A) True
B) False
Ans: A
Format: True/False
6. The operating cycle begins when the firm uses its cash to purchase raw materials and
ends when the firm collects cash payments on its credit sales.
A) True
B) False
Ans: B
Format: True/False
7. The cash conversion cycle is the length of time between the cash outflow for materials
and the cash inflow from sales.
A) True
B) False
Ans: A
Format: True/False
8. Days' payables outstanding (DPO), which tells how long a firm takes to pay off its
suppliers for the cost of inventory, is used to measure the operating cycle.
A) True
B) False
Ans: B
Format: True/False
9. Days' payables outstanding (DPO) tells how long a firm takes to pay off its suppliers
for the cost of inventory.
A) True
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B) False
Ans: A
Format: True/False
10. An efficient firm with good working capital management should have a high average
collection period compared to its industry.
A) True
B) False
Ans: B
Format: True/False
11. The flexible strategy calls for management to invest large amounts in cash, marketable
securities, and inventory.
A) True
B) False
Ans: A
Format: True/False
12. The flexible strategy is perceived be a high-risk and low-return course of action for
management to follow.
A) True
B) False
Ans: B
Format: True/False
13. The restrictive strategy is a high-risk, high-return alternative to the flexible strategy.
A) True
B) False
Ans: A
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Format: True/False
14. The conflict between carrying costs versus shortage costs is called the working capital
trade-off.
A) True
B) False
Ans: A
Format: True/False
15. If shortage costs dominate carrying costs, the firm will need to move toward a more
flexible policy.
A) True
B) False
Ans: A
Format: True/False
16. If carrying costs are less than shortage costs, then the firm will maximize value by
adopting a more restrictive strategy.
A) True
B) False
Ans: B
Format: True/False
Level of Difficulty: Medium
17. Trade credit, which is short-term financing, comes with an explicit interest charge.
A) True
B) False
Ans: B
Format: True/False
18. An offer of 3/10, net 40 means that the selling firm offers a 10 percent discount if the
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buyer pays the full amount of the purchase in cash within 3 days of the invoice date.
Otherwise, the buyer has 40 days to pay the balance in full from the date of delivery.
A) True
B) False
Ans: B
Format: True/False
19. Trade credit is a cheap loan from the supplier.
A) True
B) False
Ans: B
Format: True/False
20. The aging schedule shows the breakdown of the firm's accounts receivable by their date
of sale.
A) True
B) False
Ans: A
Format: True/False
21. A firm that employs just-in-time management has to increase its investment in working
capital.
A) True
B) False
Ans: B
Format: True/False
22. Float is the time taken by a credit customer to pay the firm.
A) True
B) False
Ans: B
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Format: True/False
23. A lockbox system allows geographically dispersed customers to send their payments to
a post office box close to them.
A) True
B) False
Ans: A
Format: True/False
24. Under the maturity matching strategy, a firm funds all seasonal demands with short-
term borrowing.
A) True
B) False
Ans: A
Format: True/False
25. Short term funding strategy calls for all working capital and a portion of fixed assets to
be funded with short-term debt.
A) True
B) False
Ans: A
Format: True/False
26. An informal line of credit is short term debt promissory notes issued by large financial
firms.
A) True
B) False
Ans: B
Format: True/False
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27. A factor is an individual or financial institution that buys accounts receivable without
recourse.
A) True
B) False
Ans: A
Format: Multiple Choice

28. Which one of the following statements is NOT true?
A) Gross working capital is the funds invested in a company's current liabilities.
B) Net working capital (NWC) refers to the difference between current assets and
current liabilities.
C) Working capital efficiency refers to the length of time between when a working
capital asset is acquired and when it is converted into cash.
D) Working capital management involves making decisions regarding the use and
sources of current assets.
Ans: A

A) The higher the cash balance, the better the ability of the firm to meet its short-
term financial obligations.
B) The lower the cash balance, the better the ability of the firm to meet its short-term
financial obligations.
C) The level of the cash balance has no bearing on the firm's ability to meet its short-
term financial obligations.
D) None of the above.
Ans: B

30. The cash conversion cycle
A) shows how long the firm keeps its inventory before selling it.
B) begins when the firm invests cash to purchase the raw materials that would be
used to produce the goods that the firm manufactures.
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C) begins when the firm uses its cash to purchase raw materials and ends when the
firm collects cash payments on its credit sales.
D) estimates how long it takes on average for the firm to collect its outstanding
accounts receivable balance.
Ans: B

A) The cash conversion cycle begins when the firm invests cash to purchase the raw
materials that would be used to produce the goods that the firm manufactures.
B) The cash conversion cycle begins when the firm uses its cash to purchase raw
materials and ends when the firm collects cash payments on its credit sales.
C) To measure the cash conversion cycle, we need another measure called the days'
payables outstanding.
D) The cash conversion cycle ends not with the finished goods being sold to
customers and the cash collected on the sales; but when you take into account the
time taken by the firm to pay for its purchases.
Ans: B

32. The operating cycle
A) begins when the firm receives the raw materials it purchased that would be used
to produce the goods that the firm manufactures.
B) begins when the firm uses its cash to purchase raw materials and ends when the
firm collects cash payments on its credit sales.
C) To measure operating cycle we need another measure called the days' payables
outstanding.
D) ends not with the finished goods being sold to customers and the cash collected
on the sales; but when you take into account the time taken by the firm to pay for
its purchases.
Ans: A

33. Which ONE of the following statements is true when managing working capital
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accounts?
A) Maintain minimal raw material inventories without causing manufacturing
delays.
B) Use as little labor as possible to manufacture the product while producing a
quality product.
C) Delay paying accounts payable as long as possible without suffering any
penalties.
D) All of the above are true.
Ans: D

34. Which ONE of the following statements is true?
A) Cash conversion cycle = DSO + DSI + DPO
B) Cash conversion cycle = DSO + DSI - DPO
C) Cash conversion cycle = DSO - DPO
Ans: B

A) Cash conversion cycle = DSO + DSI - DPO
B) Operating cycle = DSO + DSI
C) a and b
D) None of the above
Ans: D

36. The flexible current asset investment strategy
A) has a high percent of current assets to sales.
B) calls for management to invest large amounts in cash, marketable securities, and
inventory.
C) leads to high levels of accounts receivable.
D) All of the above.
Ans: D
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37. Which one of the following is NOT true about the flexible current asset investment
strategy?
A) The strategy promotes a liberal trade credit policy for customers.
B) The flexible strategy calls for management to invest large amounts in cash,
marketable securities, and inventory.
C) The flexible strategy is perceived be a high-risk and high-return course of action
for management to follow.
D) The strategy's downside is the high inventory carrying cost.
Ans: C

38. A restrictive current asset investment strategy calls for
A) current assets kept to a minimum.
B) the firm barely investing in cash and inventory.
C) tight terms of sale intended to curb credit sales and accounts receivable.
D) All of the above
Ans: D

39. The restrictive strategy is a high-risk, high-return alternative to the flexible strategy
because of
A) financial shortage costs.
B) production shortage costs.
C) human resources shortages costs.
Ans: A

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A) Financial shortage costs arise mainly from illiquidity—shortage of cash or a lack
of marketable securities to sell for cash.
B) Operating shortage costs result from lost production and sales.
C) Operating shortage costs can be substantial, especially if the product markets are
competitive.
Ans: D

41. Operating shortage costs that result from lost production and sales are caused by
A) not holding enough raw materials in inventory.
B) running out of finished goods.
C) restrictive sale policies.
Ans: D

42. Which ONE of the following statements about working capital tradeoff is true?
A) Financial managers need to balance shortage costs against carrying costs to find
an optimal strategy.
B) If carrying costs are larger than shortage costs, then the firm will maximize value
by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a
more flexible policy.
D) All of the above
Ans: D

43. Which one of the following statements about working capital trade-off is NOT true?
A) Financial managers need to balance shortage costs against carrying costs to find
an optimal strategy.
B) If carrying costs are smaller than shortage costs, then the firm will maximize
value by adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a
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more flexible policy.
D) Management will try to find the level of current assets that minimizes the sum of
the carrying costs and shortage costs.
Ans: B

44. The aging schedule
A) shows the breakdown of the firm's accounts receivable by their date of sale.
B) identifies and then tracks delinquent accounts and to see that they are paid.
C) are an important financial tool for analyzing the quality of a company's
receivables.
Ans: D

A) The economic order quantity (EOQ) mathematically determines the minimum
total inventory cost.
B) The EOQ takes into account reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) All of the above
Ans: D

A) The economic order quantity (EOQ) mathematically determines the minimum
total inventory cost.
B) The EOQ ignores reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
Ans: B

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47. Which one of the following statements about just-in-time inventory management policy
is NOT true?
A) It calls for the exact day-by-day, or even hour-by-hour raw material needs to be
delivered by the suppliers.
B) If the supplier fails to make the needed deliveries, then production shuts down.
C) A big disadvantage in this system is that there are high raw inventory costs.
D) It eliminates obsolescence or loss to theft.
Ans: C

48. Which one of the following statements about collection time is NOT true?
A) Collection time, or float, is the time between when a customer makes a payment
and when the cash becomes available to the firm.
B) Collection time can be broken down into three components.
C) Delivery time or mailing time is not part of the float.
D) Processing delay is part of the collection time.
Ans: C

49. Which ONE of the following statements about matching maturity strategy is true?
A) All working capital is funded with short-term borrowing.
B) As the level of sales varies seasonally, short-term borrowing fluctuates between
some minimum and maximum level.
C) All fixed assets are funded with long-term financing.
Ans: D

50. Which ONE of the following statements about short term funding strategy is true?
A) All working capital and a portion of fixed assets are funded with short-term debt.
B) This strategy lowers the cost under some interest rate scenarios.
C) It forces the firm to continually refinance the funding of the long-term assets in a
changing interest rate environment.
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Ans: D

A) Firms using matching maturity strategy fund all working capital needs with long-
term borrowing.
B) Long-term financing strategy relies on long-term debt to finance both capital
assets and working capital.
C) All working capital and a portion of fixed assets are funded with short-term debt
when firms use the aggressive funding strategy.
D) Firms using a matching maturity strategy fund all working capital needs with
short-term borrowing.
Ans: A

A) Accounts payable (trade credit), bank loans, and commercial paper are common
sources of short-term financing.
B) An informal line of credit is a verbal agreement between the firm and the bank,
allowing the firm to borrow up to an agreed-upon upper limit.
C) An informal line of credit is also known as “revolving credit.”
D) A formal line of credit is also known as “revolving credit.”
Ans: C

53. Operating cycle: Trend Foods distributes its products to more than 100 restaurants and
delis. The company's collection period is 32 days, and it keeps its inventory for 10 days.
What is Trend's operating cycle?
A) 22 days
B) 32 days
C) 42 days
Ans: C
Feedback:
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DSI = 10 days
DSO = 32 days
Operating cycle = DSO + DSI
= 32 + 10
= 42 days

54. Operating cycle: Stamp, Inc., has an operating cycle of 81 days and takes 47 days to
collect on its receivables. What is its level of inventory if the firm's cost of goods sold
is $312,455? Round to the nearest dollar.
A) $9,190
B) $14,685
C) $29,105
D) $69,339
Ans: C
Feedback:
Operating cycle = 81 days
DSO = 47 days
Cost of goods sold = $19,630
DSI = OC – DSO = 81 – 47 = 34 days
Inventory Inventory Inventory
DSI = 34 days = = =
COGS 365 $312,455 365 $856.04
Inventory = 34 �856.04 = $29,105.40

55. Operating cycle: Le Baron Company, a men's designer firm, has an operating cycle of
123 days. The firm's days' sales in inventory is 73 days. How much does the firm have
in receivables if it has credit sales of $433,450? Round to the nearest dollar.
A) $59,377
B) $71,252
C) $47,501
D) $64,233
Ans: A
Feedback:
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DSI = 73 days
DSO = OC – DSI = 123 – 73 = 50 days
Credit sales = $433,450
Accounts receivables Accounts receivables
DSO = = = 50 days
Credit sales 365 $433, 450 365
Accounts receivables = 50 �$1,187.53 = $59, 376.71

56. Operating cycle: All Stars, Inc., has inventory of $44,233 and cost of goods sold of
$512,902. The company has an operating cycle of 74 days. What is the firm's days'
sales outstanding (DSO)?
A) 43 days
B) 32 days
C) 49 days
D) 26 days
Ans: A
Feedback:
Cost of goods sold = 212,902
Inventory = $44,233
Inventory $44,233
DSI = = = 31.5 days
COGS 365 $512,902 365
DSO = OC – DSI = 74 – 31.5 = 42.5 days
Use the following to answer questions 57-58:
You are provided the following working capital information for the Ridge Company:
Ridge Company
Account $
Inventory $12,890
Accounts 12,800
receivable
Accounts payable 12,670
Net sales $124,589
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Cost of goods sold 99,630
Reference: Ref 14-1

57. Operating cycle: What is the operating cycle for Ridge Company?
A) 47 days
B) 85 days
C) 36 days
D) 51 days
Ans: B
Feedback:
Accounts receivables = $12,800
Accounts payables = $12,670
Net sales = $124,589
Inventory = $12,890
Reference: Ref 14-1

58. Cash conversion cycle: What is the cash conversion cycle for Ridge Company?
A) 83.5 days
B) 38.3 days
C) 129.9 days
D) 46.4 days
Ans: B
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Feedback:
Inventory = $12,890

59. Cash conversion cycle: Wolfgang Electricals estimates that it takes the company 31
days on average to pay off its suppliers. It also knows that it has days' sales in inventory
of 54 days and days sales' outstanding of 34 days. What is its cash conversion cycle?
A) 119 days
B) 34 days
C) 57 days
D) 46 days
Ans: C
Feedback:
Feedback for Question 57:
DPO = 31
DSI = 54
DSO = 34
Cash conversion cycle = DSO + DSI – DPO
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=34 + 54 – 31 = 57

60. Cash conversion cycle: Renald Corp. estimates that it takes the company 27 days on
average to pay off its suppliers. It also knows that it has days' sales in inventory of 43
days and days sales' outstanding of 45 days. What is its cash conversion cycle?
A) 61 days
B) 115 days
C) 57 days
D) 46 days
Ans: A
Feedback:
DPO = 27 days
DSI = 43 days
DSO = 45 days
Renald's cash conversion cycle =
Cash conversion cycle = DSO + DSI - DPO
= 45 + 43 - 27
= 61 days

61. Cash conversion cycle: Your boss asks you to compute the company's cash conversion
cycle. Looking at the financial statements, you see that the average inventory for the
year was $126,300, accounts receivable were $97,900, and accounts payable were at
$115,100. You also see that the company had sales of $324,000 and that cost of goods
sold was $282,000. What is your firm's cash conversion cycle? Round to the nearest
day.
A) 119 days
B) 34 days
C) 57 days
D) 125 days
Ans: D
Feedback:
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Inventory = $126,300
Accounts receivables $97,900
DSO = = = 110.3 days
Credit sales 365 $324, 000 365
Inventory $126,300
DSI = = = 163.5 days
COGS 365 $282, 000 365
Accounts payables $115,100
DPO = = = 149 days
COGS 365 $282, 000 365
Cash conversion cycle = DSO + DSI - DPO
= 110.3 + 163.5 - 149
= 124.8 days

62. Cash conversion cycle: West Handicrafts, Inc., has net sales of $423,000 with 30
percent of it being credit sales. Its cost of goods sold is $324,000. The firm's cash
conversion cycle is 47.9 days. The firm's operating cycle is 86.3 days. What is the
firm's accounts payable? Round to the nearest dollar
A) $34,087
B) $126,900
C) $71,203
D) $56,322
Ans: A
Feedback:
Credit sales = (0.3 x $423,000) = $126,900
Cash conversion cycle = 47.9 days
Operating cycle = 86.3 days
Cash conversion cycle = ( DSO + DSI ) - DPO
47.9 = 86.3 - DPO
DPO = 38.4 days
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Accounts payables Accounts payables
DPO = = = 38.4 days
COGS 365 $324, 000 365
Accounts payables = 38.4 �$887.67 = $34, 086.53

The firm has accounts payables of $34,087.

63. Effective interest rate: Serengeti Travels has borrowed $50,000 at a stated APR of 8.5
percent. The loan calls for a compensating balance of 8 percent. What is the effective
interest rate for this company?
A) 9.24%
B) 8.50%
C) 8.00%
D) 16.50%
Ans: A
Feedback:
Amount to be borrowed = $50,000
Stated annual interest rate = 8.5%
Compensating balance = 8%
Amount deposited as compensating balance = $50,000 x 0.08 = $4,000
Effective borrowing amount = $50,000 – $4,000 = $46,000
Interest expense = $50,000 x 0.085 = $4,250
Interest expense $4,250
Effective interest rate = = = 9.24%
Effective borrowing amount $46,000

64. Effective interest rate: Sun Prairie Traders borrowed $63,000 at an APR of 10 percent.
The loan called for a compensating balance of 10 percent. What is the effective interest
rate on the loan?
A) 10.00%
B) 11.11%
C) 8.00%
D) 12.50%
Ans: B
Feedback:
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Stated annual interest rate = 10%
Amount deposited as compensating balance = $63,000 x 0.10 = $6,300
Effective borrowing amount = $63,000 – $6,300 = $56,700
Interest expense $6,300
Effective interest rate = = = 11.11%
Effective borrowing amount $56,700

65. Effective interest rate: Good Homes Furnishings is borrowing $225,000. The loan
requires a 10 percent compensating balance, and the effective interest rate on the loan is
8.25 percent. What is the stated APR on this loan? Round to one decimal place.
A) 10.00%
B) 11.11%
C) 7.4%
D) 8.25%
Ans: C
Feedback:
Stated annual interest rate = ?
Effective interest rate = 8.25%
Compensating balance = (0.10 x $225,000) = $22,500
Effective borrowed amount = $225,000 – $22,500 = $202,500
Interest expense
Effective interest rate =
Effective borrowing amount
Interest expense
8.25% =
$202,500
Interest expense = 0.0825 �$202,500 = $16, 706.25
Stated interest rate = $16,706.25 / $225,000 =7.425%

66. Effective interest rate: Maggie's Bistro is borrowing $375,000. The loan requires an 8
percent compensating balance, and the effective interest rate on the loan is 10.326
percent. What is the stated APR on this loan? Round to one decimal place.
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A) 10.0%
B) 9.5%
C) 7.4%
D) 8.5%
Ans: B
Feedback:
Stated annual interest rate = ?
Effective interest rate = 10.326%
Compensating balance = (0.08 x $375,000) = $30,000
Effective borrowed amount = $375,000 – $30,000 = $345,000
Interest expense
Effective borrowing amount
Interest expense
10.326% =
$345, 000
Interest expense = 0.10326 �$345, 000 = $35, 625
Stated interest rate = $35,625 / $375,000 =9.5%

67. Formal line of credit: Gibbs, Inc., has just set up a formal line of credit of $1 million
with First National Bank. The line of credit is good for up to five years. The bank will
be charging them an interest rate of 6.25 percent on the loan, and in addition the firm
will pay an annual fee of 50 basis points on the unused balance. The firm borrowed
$600,000 on the first day the credit line became available. What is the firm's effective
interest rate on this line of credit?
A) 8.00%
B) 7.25%
C) 6.58%
D) 8.25%
Ans: C
Feedback:
Line of credit limit = $1,000,000
Loan rate = 6.25%
Annual fee on unused balance = 0.5%
Amount borrowed = $600,000
Unused balance = $400,000
Annual fee = $400,000 x 0.005 = $2,000
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Interest expense + Annual fee
Borrowed amount
($37,500 + $2,000)
= = 6.58%
$600,000

68. Formal line of credit: Trend, Inc., has just set up a formal line of credit of $5 million
with First National Bank. The line of credit is good for up to three years. The bank will
be charging them an interest rate of 7.5 percent on the loan, and in addition the firm
will pay an annual fee of 50 basis points on the unused balance. The firm borrowed
$2,300,000 on the first day the credit line became available. What is the firm's effective
interest rate on this line of credit? Round to one decimal place.
A) 8.5%
B) 7.25%
C) 9.0%
D) 8.1%
Ans: D
Feedback:
Loan rate = 7.5%
Amount borrowed = $2,300,000
Unused balance = $2,700,000
Annual fee = $2,700,000 x 0.005 = $13,500
Interest expense = $2,300,000 x 0.075 = $172,500
Borrowed amount
($172,500 + $13,500)
= = 8.09%
$2,300,000

69. Formal line of credit: Storm Electronics has set up a formal line of credit of $2 million
with First Kentucky Bank. The line of credit is good for up to three years. The bank
will be charging them an interest rate of 6.25 percent on the loan, and in addition the
firm will pay an annual fee of 60 basis points on the unused balance. The firm
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borrowed $1,500,000 on the first day the credit line became available. What is the
firm's effective interest rate on this line of credit? Round to two decimal places.
A) 7.50%
B) 6.45%
C) 6.25%
D) 7.15%
Ans: B
Feedback:
Loan rate = 6.25%
Amount borrowed = $1,500,000
Unused balance = $500,000
Annual fee = $500,000 x 0.006 = $3,000
Interest expense = $1,500,000 x 0.0625 = $93,750
Borrowed amount
($93,750 + $3,000)
= = 6.45%
$1,500,000

70. Lockbox: Porter Corp. has just signed up for a lockbox. Management expects the
lockbox to reduce the mail float by 2.3 days. The firm's remittances average $41,250 a
day, with the average check being $165. The bank charges $0.39 per processed check.
Assume that there are 270 business days in a year and their opportunity cost of funds is
5 percent. What will the firm's savings be from using the lockbox?
A) $4,743.75
B) $975.50
C) $2,632.50
D) $94,875.00
Ans: A
Feedback:
Average daily sales = $41,250
No. of business days = 270
Average check amount = $165
No. of checks processed per day = $41,250 / $165 = 250
Collection time saved = 2.3 days
Per check processing fee = $0.39
The cost of a lockbox = 250 checks × $0.39 per check × 270 days = $26,325
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Savings from mail float = 2.3 days × $41,250 = $94,875
Savings from lockbox = ($94,875 – $26,325) = $68,550 x .05 = $4,743.75

71. Lockbox: Rocky Corp. has daily sales of $18,100. The financial manager determined
that a lockbox would reduce the collection time by 2.2 days. Assuming the company
can earn 6 percent interest per year, what are the savings from the lockbox? Round to
the nearest dollar.
A) $3,620.50
B) $2,389.20
C) $39,820
D) $1,100.45
Ans: B
Feedback:
Average daily sales = $18,100
Collection time saved = 2.2 days
Savings from mail float = 2.2 days × $18,100 = $39,820
Savings if invested = $39,820 x 0.06 = $2,389.20

72. Cost of trade credit: Senter Corp. sells its goods with terms of 2/10 EOM, net 30.
What is the implicit cost of the trade credit?
A) 18.50%
B) 30.00%
C) 44.59%
D) 21.89%
Ans: C
Feedback:
Credit terms = 2/10 EOM, net 30
Effective annual rate � Discount �
365/ days credit
�1+ � -1
� Discounted price �
=
= (1 + 2/98)365/20 – 1
= (1.0204)18.2500 – 1
= 1.4459 – 1
= 0.4459, or 44.59%
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73. Cost of trade credit: Kearns, Inc., sells its goods with terms of 3/15 EOM, net 60.
What is the implicit cost of the trade credit?
A) 15%
B) 45%
C) 34%
D) 28%
Ans: D
Feedback:
Credit terms = 3/15 EOM, net 60
Effective annual � Discount
365/ days credit
�
rate 1+
� � -1
� Discounted price �
=
= (1 + 3/97)365/45 – 1
= (1.0309)8.1111 – 1
= 1.2800– 1
= 0.28, or 28%

74. Factoring: Pride, Inc., sells $150,000 of its accounts receivable to factors at 2.875
percent discount. The firm's average collection period is 75 days. What is the simple
annual interest cost of the factors loan?
A) 35.5%
B) 32.9%
C) 27.8%
D) 31.1%
Ans: A
Feedback:
Accounts receivables sold = $150,000
Factor discount = 2.875%
Average collection period = 75 days
Dollar cost of factoring per month = $150,000 x 0.02875 = $4,312.50
Simple monthly interest cost of factoring = 2.875/97.125 = 0.0296
Simple interest cost of factoring = 0.0296 x 12 = 35.5%
Page 27
75. Factoring: A firm sells $125,000 of its accounts receivable to factors at 3 percent
discount. The firm's average collection period is one month. What is the dollar cost of
the factoring service?
A) $3,000
B) $4,500
C) $3,750
D) $4,250
Ans: C
Feedback:
Accounts receivables sold = $125,000
Factor discount = 3%
Average collection period = 30 days
Dollar cost of factoring per month = $125,000 x 0.03 = $3,750
Use the following to answer questions 76-77:
Economic order quantity: Jensen Autos, one of the largest car dealers in Eau Claire, sells about
700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory
carrying costs are $120 for each car. Most of their sales are in late fall of each year.
Reference: Ref 14-2

76. What is the number of cars per order?
A) 80 cars
B) 101cars
C) 58 cars
D) 113 cars
Ans: D
Feedback:
Annual sales = 700 units
Cost of placing an order = $1,100
Inventory carrying cost = $120
2 �Reorder costs �Sales per period
EOQ =
Carrying cos ts
2 �$1,100 �700
= = 113.3
$120
Page 28
Economic order quantity = 113 cars
Reference: Ref 14-2

77. How many orders will the dealer need to place this year?
A) 4 orders
B) 5 orders
C) 6 orders
D) 7 orders
Ans: C
Feedback:
Number of orders = 700 / 113 @ 6

Level of Difficulty: Basic
78. Which of the following is the equation for net working capital?
A) Total assets – total liabilities
B) Current assets – current liabilities
C) Current assets/current liabilities
D) Total assets/total liabilities
Ans: B

Level of Difficulty: Basic
79. Which of the following is a short-term financing instrument?
A) Accounts payable
B) Bank loans with a maturity of less than 1 year
C) Commercial paper
D) All of the above
Ans: D
Page 29
80. Ticktock Clocks sells 10,000 alarm clocks each year. If the total cost of placing an
order is $65 and it costs $85 per year to carry the alarm clock in inventory, use the EOQ
formula to calculate the optimal order size.
A) 124 clocks
B) 161 clocks
C) 15,294 clocks
D) 26,154 clocks
Ans: A
Feedback:
2  Reorder costs  Sales per period
EOQ =
Carrying cos ts
2  $65  10,000
= = 123.7
$85
Economic order quantity = 124 clocks
Format: Essay
81. What are some strategies that financial managers can follow in managing their working
capital accounts?
Ans: When managing working capital accounts, financial managers want to do the
following:
· Delay paying accounts payable as long as possible without suffering any penalties.
· Maintain minimal raw material inventories without causing manufacturing delays.
· Use as little labor as possible to manufacture the product while producing a quality
product.
· Maintain minimal finished goods inventories without losing sales.
· Offer customers the most attractive credit terms possible on trade credit to
maximize sales while minimizing the risk of nonpayment.
· Collect cash payments on accounts receivable as fast as possible to close the loop.
Format: Essay
82. Explain working capital trade-off.
Ans: The optimal current asset investment strategy will depend on the relative
magnitudes of carrying costs versus shortage costs. This conflict is often referred
to as the working capital trade-off.
Financial managers need to balance shortage costs against carrying costs to find
Page 30
an optimal strategy. If carrying costs are larger than shortage costs, then the firm
will maximize value by adopting a more restrictive strategy. On the other hand, if
shortage costs dominate carrying costs, the firm will need to move toward a more
flexible policy. Overall, management will try to find the level of current assets
that minimizes the sum of the carrying costs and shortage costs.
Format: Essay
83. How does the just-in-time inventory management work?
Ans: In this system the exact day-by-day, or even hour-by-hour raw material needs are
delivered by the suppliers, who deliver the goods “just in time” for them to be
used on the production line. A big advantage in this system is that there are
essentially no raw inventory costs and no chance of obsolescence or loss to theft.
On the other hand, if the supplier fails to make the needed deliveries, then
production shuts down. If the system works for a firm, it cuts down their
investment in working capital dramatically.
Page 31

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Format: True/False

Format: Multiple Choice

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Use the following to answer questions 57-58:

Net sales $124,589

Reference: Ref 14-1

Reference: Ref 14-1

Format: Multiple Choice

Format: Multiple Choice

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Format: Multiple Choice

Accounts payables = 38.4 �$887.67 = $34, 086.53

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Use the following to answer questions 76-77:

Reference: Ref 14-2

Reference: Ref 14-2

Format: Multiple Choice

Format: Multiple Choice

Format: Multiple Choice

Economic order quantity = 124 clocks

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