Unformatted text preview: CHAPTER 15-A
Working Capital Management
Multiple Choice: Conceptual
1. Other things held constant,
increase in working capital? Answer: c
which of the following will Diff: E
cause an a.
d. Cash is used to buy marketable securities.
A cash dividend is declared and paid.
Merchandise is sold at a profit, but the sale is on credit.
Long-term bonds are retired with the proceeds of a preferred stock
e. Missing inventory is written off against retained earnings.
2. Customers' payments patterns are changing.
Sales fluctuate seasonally.
Some customers take the discount and others do not.
Sales are relatively constant, either seasonally or cyclically.
None of the answers above. Credit policy Answer: e Diff: E Which of the following is not commonly regarded as being a credit policy
e. Credit period.
All of the answers above are credit policy variables. Credit policy
4. Diff: E Analyzing days sales outstanding (DSO) and the aging schedule are two
common methods for monitoring receivables.
However, they can provide
erroneous signals to credit managers when
e. 3. Answer: b Answer: e Diff: E If easing a firm's credit policy lengthens the collection period and
results in a worsening of the aging schedule, then why do firms take
e. It normally stimulates sales.
To meet competitive pressures.
To increase the firm's deferral period for payables.
All of the answers above.
Both answers a and b above. Chapter 15a - Page 1 Inventory management
5. Answer: d Diff: E In the text, the "red-line method" refers to
a. The policy of drawing a red line around certain neighborhoods on a
map and then refusing to sell on credit to people who live within
b. Restrictions imposed by companies which insure credit risks.
c. The use, in Dun & Bradstreet's reports, of a red line to show the
maximum amount of credit which should be extended to a given
customer; companies using this limit when they screen customers'
orders are said to be using the "red-line method."
d. A method of controlling inventories by drawing a red line on the
inside of a bin.
e. A method of controlling receivables by drawing a red line on invoices
of companies that are expected to pay late. Inventory management
6. Which of the
e. following might be attributed to efficient Diff: E inventory High inventory turnover ratio.
Low incidence of production schedule disruptions.
High total assets turnover.
All of the answers above.
Only answers a and c above. Cash conversion cycle
7. Answer: d Answer: e Diff: M N Which of the following actions are likely to reduce the length of a
company’s cash conversion cycle?
a. Adopting a just-in-time inventory system which reduces the inventory
b. Reducing the average days sales outstanding (DSO) on its accounts
c. Reducing the amount of time the company takes to pay its suppliers.
d. All of the answers above are correct.
e. Answers a and b are correct. Chapter 15a - Page 2 Cash balances
8. Answer: c Diff: M Which of the following statements is most correct?
compensating, precautionary, and speculative balances.
desired cash balance can be determined by calculating the amount
needed for each purpose and then summing them together.
b. The easier a firm's access to borrowed funds the higher its
precautionary balances will be, in order to protect against sudden
increases in interest rates.
c. For some firms, holding highly liquid marketable securities is a
substitute for holding cash because the marketable securities
accomplish the same objective as cash.
d. Firms today are more likely to rely on cash than on reserve borrowing
power or marketable securities for speculative purposes because of
the need to move quickly.
e. Each of the statements above is false. Float
9. Answer: a Diff: M Which of the following statements is most correct?
a. Poor synchronization of cash flows which results in high cash
management costs can be partially offset by increasing disbursement
float and decreasing collections float.
b. The size of a firm's net float is primarily a function of its natural
cash flow synchronization and how it clears its checks.
c. Lockbox systems are used mainly for security purposes as well as to
decrease the firm's net float.
d. If a firm can speed up its collections and slow down its
disbursements, it will be able to reduce its net float.
e. A firm practicing good cash management and making use of positive net
float will bring its check book balance as close to zero as possible,
but must never generate a negative book balance. Chapter 15a - Page 3 Receivables management
10. Answer: b Diff: M Which of the following statements is most correct?
a. A firm which makes 90 percent of its sales on credit and 10 percent
for cash is growing at a rate of 10 percent annually. If the firm
maintains stable growth it will also be able to maintain its accounts
receivable at its current level, since the 10 percent cash sales can
be used to manage the 10 percent growth rate.
b. In managing a firm's accounts receivable it is possible to increase
credit sales per day yet still keep accounts receivable fairly steady
if the firm can shorten the length of its collection period.
c. If a firm has a large percentage of accounts over 30 days old, it is
a sign that the firm's receivables management needs to be reviewed
d. Since receivables and payables both result from sales transactions, a
firm with a high receivables-to-sales ratio should also have a high
e. All of the statements above are false. Credit policy and seasonal dating
11. Answer: b Diff: M Which of the following statements is most correct?
a. If credit sales as a percentage of a firm's total sales increases,
and the volume of credit sales also increases, then the firm's
accounts receivable will automatically increase.
b. It is possible for a firm to overstate profits by offering very
lenient credit terms which encourage additional sales to financially
"weak" firms. A major disadvantage of such a policy is that it is
likely to increase uncollectible accounts.
c. A firm with excess production capacity and relatively low variable
costs would not be inclined to extend more liberal credit terms to
its customers than a firm with similar costs that is operating close
d. Firms use seasonal dating primarily to decrease their DSO.
e. Seasonal dating with terms 2/15, net 30 days, with April 1 dating,
means that if the original sale took place on February 1st, the
customer can take the discount up until March 15th, but must pay the
net invoice amount by April 1st. Chapter 15a - Page 4 Working capital policy
12. Answer: d Diff: M Which of the following statements is incorrect about working capital
a. A company may hold a relatively large amount of cash if it
anticipates uncertain sales levels in the coming year.
b. Credit policy has an impact on working capital since it has the
potential to influence sales levels and the speed with which cash is
c. The cash budget is useful in determining future financing needs.
d. Holding minimal levels of inventory can reduce inventory carrying
costs and cannot lead to any adverse effects on profitability.
e. Managing working capital levels is important to the financial staff
since it influences financing decisions and overall profitability of
the firm. Multiple Choice: Problems
13. Diff: E The Danser Company expects to have sales of $30,000 in January, $33,000
in February, and $38,000 in March. If 20 percent of sales are for cash,
40 percent are credit sales paid in the month following the sale, and 40
percent are credit sales paid 2 months following the sale, what are the
cash receipts from sales in March?
$30,000 Accounts receivable balance
14. Answer: d Answer: a Diff: E If Hot Tubs Inc. had sales of $2 million per year (all credit) and its
days sales outstanding was equal to 35 days, what was its average amount
of accounts receivable outstanding (assume a 360-day year)?
$212,541 Chapter 15a - Page 5 Cash conversion cycle
15. Answer: b Diff: M N Kolan Inc. has annual sales of $36,500,000 ($100,000 a day on a 365day basis). On average, the company has $12,000,000 in inventory and
$8,000,000 in accounts receivable. The company is looking for ways
to shorten its cash conversion cycle (calculated on a 365-day basis).
Their CFO has proposed new policies which would result in a 20
receivables. The company anticipates that these policies will also
reduce sales by 10 percent. Accounts payable will remain unchanged.
What effect would these policies have on the company's cash
days Chapter 15a - Page 6 shorter
longer CHAPTER 15-A
Answers and Solutions
1. Working capital Answer: c Diff: E 2. Monitoring receivables Answer: b Diff: E 3. Credit policy Answer: e Diff: E 4. Credit policy Answer: e Diff: E 5. Inventory management Answer: d Diff: E 6. Inventory management Answer: d Diff: E 7. Cash conversion cycle Answer: e Diff: M N Statements a and b are both correct; therefore, statement e is the
appropriate choice. Delaying payments to suppliers increases the length
of the cash conversion cycle.
8. Cash balances Answer: c Diff: M 9. Float Answer: a Diff: M 10. Receivables management Answer: b Diff: M 11. Credit policy and seasonal dating Answer: b Diff: M 12. Working capital policy Answer: d Diff: M Statements a, b, c and e are all correct statements.
Statement d is
incorrect, and thus the right answer.
Holding minimal levels of
inventory may result in lost sales.
13. Sales collections Answer: d Diff: E March
receipts = (0.20)($38,000) + (0.40)($33,000) + (0.40)($30,000) = $32,800. 14. Accounts receivable balance Answer: a Diff: E Accounts receivables = DSO × Sales per day = 35($2,000,000/360) = $194,444. 15. Cash conversion cycle Answer: b Diff: M N Chapter 15a - Page 7 Cash
Conversion Cycle Conversion Period Conversion Period
For this problem we are only interested in the change in the CCC. We
may therefore ignore the Payables Deferral Period since it is assumed to
Old CCC (ignore payables) = $12,000,000/$100,000 + $8,000,000/$100,000
= 120 + 80 = 200 days.
New CCC = $9,600,000/$90,000 + $6,400,000/$90,000
= 106.67 + 71.11 = 177.78 days.
Change in CCC = New CCC – Old CCC
= 177.78 – 200
= -22.22 days. Round to 22 days shorter. Chapter 15a - Page 8 ...
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