Q&A Hero

Q: 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.

Q: 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 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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. d. New shares issued in a stock split. e. New shares issued in a stock dividend.

Q: 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.

Q: 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.

Q: 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. d. Repurchases of common stock. e. Writing off bad debts.

Q: 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.

Q: 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.

Q: Which of the following statements is CORRECT? a. Net working capital is defined as operating 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 operating 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 short-term debt with its use of long-term debt.

Q: 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 500 500 Total assets $690 $620 u200b Payables and accruals $30 $10 Short-term bank debt 50 0 Long-term debt 300 300 Common equity 310 310 Total claims $690 $620 u200b 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.

Q: 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.u200b a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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.u200b a. True b. False

Q: Because money has time value, a cash sale is always more profitable than a credit sale. a. True b. False

Q: 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.u200b a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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.u200b a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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 firms working capital needs. a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: "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

Q: 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

Q: 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

Q: The calculated cost of trade credit can be reduced by paying late. a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: Changes in a firm's collection policy can affect sales, working capital, and profits. a. True b. False

Q: 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

Q: The average accounts receivables balance is a function of both the volume of credit sales and the days sales outstanding. a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: The concept of permanent current assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent current assets represent a minimum level of current assets that must be financed. a. True b. False

Q: The three alternative current asset investment policies discussed in the text differ regarding the size of current asset holdings. a. True b. False