FIN Ch. 14, Working capital and current assets management

Which of the following elements is required for the calculation of cash conversion cycle? current assets ratio average collection period average cost of goods sold cash flows from operations

average collection period

On average in recent years, U.S. firms have been increasing their cash balances relative to total assets. True False

True

Safety stocks are extra inventories that can be drawn down when actual lead times and/or usage rates are greater than expected. True False

True

Since its objective is to minimize inventory investment, a Just-in-Time (JIT) system uses no, or very little, safety stocks. True False

True

The ACH (automated clearing house) debits are preauthorized electronic withdrawals from a payer's account. True False

True

The goal of working capital management is to ________. achieve a balance between short-term and long-term assets so that they add to the achievement of a firm's overall goals achieve a balance between short-term and long-term liabilities so that they add to the achievement of a firm's overall goals achieve a balance between profitability and risk that contributes positively to a firm's value achieve a balance between a firm's non-current assets and non-current liabilities

achieve a balance between profitability and risk that contributes positively to a firm's value

Table 14.5Caren's Canoes is considering relaxing its credit standards to encourage more sales. As a result, sales are expected to increase 15 percent from 300 canoes per year to 345 canoes per year. The average collection period is expected to increase to 40 days from 30 days and bad debts are expected to double the current 1 percent level. The price per canoe is $850, the variable cost per canoe is $650 and the average cost per unit at the 300 unit level is $700. The firm's required return on investment is 20 percent. (Assume a 360-day year)What is the cost of marginal investments in accounts receivable under the proposed plan? (See Table 14.5) $1,733 $1,867 $1,617 $1,817

$1,733

Table 14.1Irish Air Services has determined several factors relative to its asset and financing mix. (a)The firm earns 10 percent annually on its current assets. (b)The firm earns 20 percent annually on its fixed assets. (c)The firm pays 13 percent annually on current liabilities. (d)The firm pays 17 percent annually on long-term funds. (e)The firm's monthly current, fixed, and total asset requirements for the previous year are summarized in the table below: The firm's monthly average seasonal funds requirement is ________. (See Table 14.1) $40,000 $17,500 $57,500 $157,500

$17,500

A firm has a cash conversion cycle of 60 days. Annual outlays are $12 million and the cost of financing is 12 percent. If the firm reduces its average age of inventory by 10 days, the annual savings is ________. (Assume a 365-day year.) $10,400 $28,800 $39,452 $14,000

$39,452

A firm is considering relaxing credit standards which will result in an increase in annual sales from $3 million to $3.75 million, a decrease in the cost of annual sales from $2,225,000 to $2,000,000, an increase in additional profit contribution from sales of $10,000, and an increase in the average collection period of 15 days, from 20 to 35 days. The bad debt loss is expected to increase from 1 percent to 1.5 percent of sales. The firm's required return on investments is 15 percent. The net result of the firm relaxing its credit standards is ________. (Assume a 360-day year.) -$16,875 $10,000 -$16,250 -$26,875

-$26,875

A firm has an average age of inventory of 90 days, an average collection period of 40 days, and an average payment period of 30 days. The firm's operating cycle is ________ days. 120 130 110 70

130

A firm has a cash conversion cycle of 120 days, an average collection period of 25 days, and an average payment period of 50 days. The firm's average age of inventory is ________ days. 95 145 45 125

145

A firm has a cash conversion cycle of 60 days and average payment period of 40 days. The firm's operating cycle is ________ days. 50 30 20 100

60 = OC - 40 OC = 60 + 40 = 100

A firm has an average age of inventory of 101 days, an average collection period of 49 days, and an average payment period of 60 days. The firm's cash conversion cycle is ________ days. 11 150 109 90

90

Table 14.1Irish Air Services has determined several factors relative to its asset and financing mix. (a)The firm earns 10 percent annually on its current assets. (b)The firm earns 20 percent annually on its fixed assets. (c)The firm pays 13 percent annually on current liabilities. (d)The firm pays 17 percent annually on long-term funds. (e)The firm's monthly current, fixed, and total asset requirements for the previous year are summarized in the table below: The firm's annual financing costs of conservative financing strategy are ________. (See Table 14.1) $21,175 $26,775 $22,775 $26,075

= $26,775

Which of the following is TRUE of inventory level? A marketing manager would like to have smaller inventories of finished products to ensure production of goods as per customer specification. A manufacturing manager would keep raw materials inventories low to ensure use of latest materials in production process. A purchasing manager would purchase higher inventories when prices are low and lower inventories when prices are high irrespective of inventory requirement. A financial manager would keep inventory levels low to ensure that the firm's money is not unwisely invested in excess resources.

A financial manager would keep inventory levels low to ensure that the firm's money is not unwisely invested in excess resources

The key dimension of credit selection which analyzes an applicant's ability to repay the requested credit focused on cash flows available is ________. conditions collateral capacity capital

Capacity

In the EOQ model, ________ costs are the variable costs per unit of holding an item of inventory for a specified time period. processing order marginal carrying

Carrying

The key dimension of credit selection which analyzes an applicant's record of meeting past obligations is ________. capacity character collateral capital

Character

The ________ is an inventory technique that takes into account various operating and financial costs to determine the order quantity for a specific inventory item. ABC system JIT system EOQ model LIFO model

EOQ model

By efficiently managing a firm's operating and cash conversion cycles, the financial manager can maintain a high level of cash investment and thereby contribute toward maximization of share value. True False

False

The reorder point is the point at which a firm receives orders. True False

False

The increase in bad debts associated with tightening credit standards raises bad debt expenses and has a negative impact on profits. True False

False, The given statement is false. The increase in bad debts associated with tightening credit standards reduces bad debt expenses and has a positive impact on profits.

In the EOQ model, if carrying costs increase while all other costs remain unchanged, the number of orders placed would be expected to increase. True False

False, the number of orders placed would be expected to decrease

Table 14.4Bowring Ball Bearings has 10 different items in its inventory. The average number of units held in inventory and the average unit cost are listed for each item. The firm uses an ABC system of inventory control. Inventory items that belong in the C category include ________. (See Table 14.4) Items 1, 7, and 9 Items 6 and 8 Items 4 and 6 Items 1 and 3

Items 1, 7, and 9

The ________ of a firm is the amount of time that elapses from the point when the firm inputs material and labor into the production process to the point when cash is collected from the sale of the finished product that contains these production inputs. average collection period cash conversion cycle operating cycle average age of inventory

Operating cycle

A security experiencing little or no loss in value over time is said to have ________. risk of payments safety of return safety of principal safety of maturity

Safety of principal

If a firm's sales are constant, its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement. True False

TRUE

The ability to purchase production inputs on credit allows a firm to partially offset the length of time resources are tied up in the operating cycle. True False

TRUE

When a portion of a firm's fixed assets are financed with current liabilities, ________. the firm will have positive net working capital the net working capital will decrease the current ratio will increase the firm will have negative net working capital

The net working capital will decrease

Which of the following is TRUE of current assets? The time of conversion of current assets to more liquid form is relatively unpredictable. They are sources of short-term financing for a firm. They are used to fund long-term operations and pay long-term expenses. They are more profitable because they add more value to the product than that provided by fixed assets.

The time of conversion of current assets to more liquid form is relatively unpredictable.

An increase in current assets increases net working capital, thereby reducing the risk of insolvency. True False

True

Controlled disbursing involves the strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively. True False

True

The cash conversion cycle of a firm is the difference between the number of days resources are tied up in the operating cycle and the average number of days the firm can delay making payment on the production inputs purchased on credit. True False

True

The operating cycle is the recurring transition of a firm's working capital from cash to inventories and inventories to receivables and back to cash. True False

True

Too much investment in current assets reduces firm's profitability, whereas too little investment in current assets increases the risk of not being able to pay debts as they come due. True False

True

In the ABC system of inventory management, the ________ method could be utilized to control C items. just-in-time materials requirement planning basic economic order quantity two-bin

Two-Bin

Which of the following is TRUE of an aggressive funding strategy of a firm? Under an aggressive funding strategy, a firm funds its seasonal requirements with short-term debt. Under an aggressive funding strategy, a firm funds it seasonal requirements with bonds and long-term loans. Under an aggressive funding strategy, a firm funds it permanent requirements with commercial paper and notes payable. Under an aggressive funding strategy, a firm funds both its seasonal and its permanent requirements with long-term debt.

Under an aggressive funding strategy, a firm funds its seasonal requirements with short-term debt.

An decrease in the current liabilities to total assets ratio will result in ________. an increase in profit a decrease in risk a decrease in profit an increase in risk

a decrease in risk

Other factors remaining constant, an increase in the average collection period will result in ________. an increase in the average payment period an increase in the operating cycle a decrease in the operating cycle a decrease in the average payment period

an increase in the operating cycle

Which of the following is one of the five C's of credit? cost control character coordination

character

________ float is the time that elapses between the deposit of a check by the payee and the actual availability of funds. Clearing Processing Disbursement Mail

clearing

Net working capital is defined as ________. total liabilities minus total assets total assets minus total liabilities current assets minus current liabilities current liabilities minus current assets

current assets minus current liabilities

A firm with a cash conversion cycle of 175 days can stretch its average payment period from 30 days to 45 days. This will result in a/an ________. increase of 30 days in the cash conversion cycle decrease of 15 days in the cash conversion cycle decrease of 30 days in the cash conversion cycle increase of 15 days in the cash conversion cycle

decrease of 15 days in the cash conversion cycle

The cost of marginal investment in accounts receivable can be calculated by finding the difference between the average investment in accounts receivable before and after the introduction of the changes in credit standards. True False

false

If a firm's credit period is decreased, the sales volume, the investment in accounts receivable, and the bad debt expenses can be expected to increase. True False

false, decrease for all

To be truly marketable, a security must have three basic characteristics: a ready market, risk-free, and safety of principal. True False

false, does not have to be risk free

When current assets exceed current liabilities, a firm has negative net working capital. True False

false, it has positive net working capital

A popular extension of materials requirement planning is inventory integration automation II, which integrates data from numerous areas such as finance, accounting, marketing, engineering, and manufacturing using a sophisticated computer system. True False

false, it is actually called manufacturing resource planning II, not inventory integration automation II

Playing the float involves the strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively. True False

false, it is not playing the float, it is called controlled disbursing

Because managing inventory is just like managing any other investment, decisions about the level of inventory should be guided by the effect of inventory levels on sales. True False

false, it should be guided by the cost-benefit analysis of the inventory, not the effect of inventory levels on sales

The more predictable a firm's cash inflows, the more net working capital it will need. True False

false, the less net working capital it will need

A long-term trend in U.S. companies is that ________. firms are decreasing their investments in current assets relative to total assets, and most of this decrease has occurred as firms decrease their inventory balances. firms are increasing their investments in current assets relative to total assets, and most of this increase has occurred as firms increase their inventory balances firms are increasing their investments in current assets relative to total assets, and most of this increase has occurred as firms increase their cash holdings firms are decreasing their investments in current assets relative to total assets, and most of this decrease has occurred as firms decrease their cash holdings

firms are decreasing their investments in current assets relative to total assets, and most of this decrease has occurred as firms decrease their inventory balances.

The conversion of current assets ________. from inventory to receivables to marketable securities provides the cash used to buy plant and equipment from cash to receivables to inventory provides the cash used to repurchase stock from cash to receivables to inventory provides the cash used to pay non-current liabilities from inventory to receivables to cash provides the cash used to pay current liabilities

from inventory to receivables to cash provides the cash used to pay current liabilities

Which of the following is an example of carrying cost? insurance of goods in transit insurance cost cost of inventory transportation cost

insurance cost

Sound cash management techniques would support ________. minimizing collection float, maximizing disbursement float, and maximizing investing cash flow maximizing collection float, minimizing disbursement float, and minimizing operating cash flow minimizing collection float, maximizing disbursement float, and minimizing the cash conversion cycle minimizing collection float, maximizing disbursement float, and minimizing the cash turnover

minimizing collection float, maximizing disbursement float, and minimizing the cash conversion cycle

The risk of an investment in a Eurodollar deposit is partially due to ________. the presence of some foreign exchange risk the fact that these instruments only pay interest at maturity the fact that the center of the Eurodollar market is in London the fact that the majority of these deposits are not in the form of U.S. dollars

the presence of some foreign exchange risk

A major decision confronting a business firm when purchasing marketable securities involves a trade-off between the opportunity to earn a return on idle funds during the holding period and the brokerage costs associated with the purchase and sale of marketable securities. True False

true

A positive cash conversion cycle means that a firm must obtain financing to support the cash conversion cycle. True False

true

Firms are able to reduce financing costs or increase the funds available for expansion by maximizing the amount of funds tied up in working capital. True False

true

If a firm relaxes its credit standards, the volume of accounts receivable increases and so does the firm's carrying cost. True False

true

In EOQ model, the average inventory is defined as the order quantity divided by 2. True False

true

Increasing the length of the credit period can increase sales, but both the investment in accounts receivable and bad debt expenses are likely to increase as well. True False

true

Marketable securities are short-term, interest-earning, money market instruments that can easily be converted into cash. True False

true

In working capital management, risk is measured by the probability that a firm will be ________. unable to repay its long-term obligations unable to pay annual dividends to stockholders unable to pay its bills as they come due unable to earn profits from day-to-day operations

unable to pay its bills as they come due