FIN EXAM 1
True
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.
False
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.
True
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.
True
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.
True
A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan.
True
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.
True
Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.
True
Accruals are "spontaneous," but unfortunately, due to law and economic forces, firms have little control over the level of these accounts.
True
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 operating asset financing strategy because of the inherent risks of using short-term financing.
False
An increase in any current asset must be accompanied by an equal increase in some current liability.
False
Because money has time value, a cash sale is always more profitable than a credit sale.
True
A conservative current operating asset financing approach will result in permanent current assets and some seasonal current assets being financed using long-term securities.
True
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.
True
A firm that follows an aggressive current asset 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.
False
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
True
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.
True
Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.
True
Changes in a firm's collection policy can affect sales, working capital, and profits.
True
Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management
False
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.
False
Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio.
True
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.
False
Real options affect the size, but not the risk, of a project's expected cash flows.
True
Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is meant to meet competition, so no increase in sales is expected. The average accounts receivable balance will probably decline as a result of this change.
True
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.
False
The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs.
True
Firms hold cash balances in order to complete transactions (both routine and precautionary) that are necessary in business operations and as compensation to banks for providing loans and services.
True
For a firm that makes heavy use of net float, being able to forecast collections and disbursement check clearings is essential.
True
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
True
Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1) when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health, and (2) long-term loan agreements are more complex.
False
If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.
False
If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables manager is not doing a good job.
True
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.
False
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 tells us that the credit department is functioning efficiently and there are no past-due accounts.
False
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.
False
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).
True
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.
True
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.
False
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.
True
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
True
Loans from commercial banks generally appear on balance sheets as notes payable. A bank's importance is actually greater than it appears from the dollar amounts shown on balance sheets because banks provide nonspontaneous funds to firms.
False
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.
True
Net operating working capital is defined as operating current assets minus operating current liabilities..
False
Net working capital is defined as current assets divided by current liabilities.
True
One of the advantages of short-term debt financing is that firms can obtain short-term credit more quickly than long-term credit.
True
One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant.
False
Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC).
False
Real options are most valuable when the underlying source of risk is very low.
False
Real options are options to buy real assets, like stocks, rather than interest-bearing assets, like bonds.
True
Real options exist when managers have the opportunity, after a project has been implemented, to make operating changes in response to changed conditions that modify the project's cash flows.
True
Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.
True
Short-term financing is riskier than long-term financing since, during periods of tight credit, the firm may not be able to rollover (renew) its debt. This is especially true if the funds are used to finance long-term assets rather than short-term assets
False
Short-term marketable securities are held for two separate and distinct purposes: (1) to provide liquidity as a substitute for cash and (2) as a non-operating investment. Marketable securities held while awaiting reinvestment are not available for liquidity purposes.
True
Shorter-term cash budgets⎯say a daily cash budget for the next month⎯are generally used for actual cash control while longer-term cash budgets⎯say monthly cash budgets for the next year⎯are generally used for planning purposes.
False
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.
False
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.
False
Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.
True
The aging schedule is a commonly used method for monitoring receivables.
True
The average accounts receivable balance is a function of both the volume of credit sales and the days sales outstanding.
True
The calculated cost of trade credit can be reduced by paying late.
True
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.
False
The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.
True
The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the average 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
True
The concept of permanent current operating 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 operating assets represent a minimum level of current assets that must be financed.
True
The four primary elements in a firm's credit policy are (1) credit standards, (2) discounts offered, (3) credit period, and (4) collection policy.
True
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.
False
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.
True
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.
True
The option to abandon a project is a real option, but a call option on a stock is not a real option.
False
The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item.
False
The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.
True
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.
True
The twin goals of inventory management are (1) to ensure that the inventories needed to sustain operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest possible level.
False
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.
True
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.
True
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.