Question 1
1.Which of the following is NOT directly reflected in the
cash budget of a firm that is in the zero tax bracket?
Payments lags.
Depreciation.
Cumulative cash.
Repurchases of common stock.
Payment for plant
construction.
Question 2
1.Which of the following statements is CORRECT?
Trade credit is provided only to relatively large, strong
firms.
Commercial paper is a form of short-term financing that is
primarily used by large, strong, financially stable companies.
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.
Commercial paper can
be issued by virtually any firm so long as it is willing to pay the going
interest rate.
Commercial paper is
typically offered at a long-term maturity of at least five years.
Question 3
A lockbox plan is
used to protect cash, i.e., to keep it from being stolen.
used to identify
inventory safety stocks.
used to slow down the
collection of checks our firm writes.
used to speed up the
collection of checks received.
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.
Question 4
1.Which of the following statements concerning the cash
budget is CORRECT?
Answer
Depreciation expense
is not explicitly included, but depreciation’s effects are reflected in the
estimated tax payments.
Cash budgets do not
include financial items such as interest and dividend payments.
Cash budgets do not
include cash inflows from long-term sources such as the issuance of bonds.
Changes that affect
the DSO do not affect the cash budget.
Capital budgeting
decisions have no effect on the cash budget until projects go into operation
and start producing revenues.
Question 5
1.Which of the following statements is CORRECT?
Answer
Depreciation is included in the estimate of cash flows (Cash
flow = Net income + Depreciation), hence depreciation is set forth on a
separate line in the cash budget.
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.
Sound working capital
policy is designed to maximize the time between cash expenditures on materials
and the collection of cash on sales.
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.
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.
Question 6
1.Other things held constant, which of the following would
tend to reduce the cash conversion cycle?
Answer
Carry a constant
amount of receivables as sales decline.
Place larger orders
for raw materials to take advantage of price breaks.
Take all discounts that are offered.
Continue to take all
discounts that are offered and pay on the net date.
Offer longer payment
terms to customers.
Question 7
1.Other things held constant, which of the following will
cause an increase in net working capital?
Answer
Cash is used to buy
marketable securities.
A cash dividend is
declared and paid.
Merchandise is sold
at a profit, but the sale is on credit.
Long-term bonds are
retired with the proceeds of a preferred stock issue.
Missing inventory is
written off against retained earnings.
Question 8
1.Which of the following statements is NOT CORRECT?
Answer
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.
Credit policy has an
impact on working capital because it influences both sales and the time before
receivables are collected.
The cash budget is
useful to help estimate future financing needs, especially the need for
short-term working capital loans.
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.
Managing working
capital is important because it influences financing decisions and the firm’s
profitability.
Question 9
1.Firms generally choose to finance temporary current
operating assets with short-term debt because
Answer
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.
short-term interest
rates have traditionally been more stable than long-term interest rates.
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.
the yield curve is
normally downward sloping.
short-term debt has a
higher cost than equity capital.
Question 10
1.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
consist mainly of long-term securities because they pay
higher rates.
consist mainly of
short-term securities because they pay higher rates.
consist mainly of
U.S. Treasury securities to minimize interest rate risk.
consist mainly of
short-term securities to minimize interest rate risk.
be balanced between
long- and short-term securities to minimize the adverse effects of either an
upward or a downward trend in interest rates.
Question 11
1.Which of the following statements is CORRECT?
Accruals are an expensive but commonly used way to finance
working capital.
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.
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.
One cannot tell if a
firm has a conservative, aggressive, or moderate current asset financing policy
without an examination of its cash budget.
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.
Question 12
1.Which of the following statements is NOT CORRECT?
Commercial paper can be issued by virtually any firm so long
as it is willing to pay the going interest rate.
Accruals are
“free” in the sense that no explicit interest is paid on these funds.
A conservative
approach to working capital management will result in most if not all permanent
current operating assets being financed with long-term capital.
The risk to a firm
that borrows with short-term credit is usually greater than if it borrowed
using long-term 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.
Bank loans generally
carry a higher interest rate than commercial paper.
Question 13
1.Which of the following statements is CORRECT?
Answer
Net working capital is defined as current assets minus the
sum of payables and accruals, and any increase in the current ratio
automatically indicates that net working capital has increased.
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.
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.
Net working capital
is defined as current assets minus the sum of payables and accruals, and any decrease
in the current ratio automatically indicates that net working capital has
decreased.
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.
Question 14
1.Which of the following statements is most consistent with
efficient inventory management? The firm has a
below average inventory turnover ratio.
low incidence of
production schedule disruptions.
below average total
assets turnover ratio.
relatively high
current ratio.
relatively low DSO.
Question 15
1.Which of the following statements is CORRECT?
Answer
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.
Conservative firms
generally use no short-term debt and thus have zero current liabilities.
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.
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.
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.
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