Drill 2 – Working Capital Management

1. In general, the more working capital a firm has,

(a) the greater its risk.
(b) the lower its risk.
(c) the less likely are creditors to lend to the firm.
(d) the lower its level of long-term funds.
2. A(n) _________ in current assets _________ net working capital, thereby _________ the risk of technical insolvency.
(a) decrease; increases; increasing
(b) increase; decreases; increasing
(c) increase; increases; reducing
(d) decrease; decreases; reducing
3. The basic strategies that should be employed by the business firm in managing cash include all of the following EXCEPT
(a) paying accounts payable as late as possible without damaging the firm’s credit rating.
(b) turning over inventory as quickly as possible, avoiding stockouts.
(c) operating in a fashion that requires maximum cash.
(d) collecting accounts receivable as quickly as possible without damaging customer rapport.
4. When a portion of the firm’s fixed assets are financed with current liabilities, the firm
(a) has positive net working capital.
(b) has negative net working capital.
(c) has excessive amounts of current assets.
(d) is in a low-risk position.
5. The purpose of managing current assets and current liabilities is to
(a) achieve as low a level of current assets as possible.
(b) achieve as low a level of current liabilities as possible.
(c) achieve a balance between profitability and risk that contributes to the firm’s value.
(d) achieve as high a level of current liabilities as possible.
6. Relative to cash flows affecting net working capital, all of the following are true EXCEPT
(a) cash inflows are generally more predictable than cash outlays.
(b) cash outlays for current liabilities are relatively predictable.
(c) the more predictable the cash inflows, the less net working capital a firm needs.
(d) because most firms are unable to match cash inflows to outflows with certainty, current assets that more than cover
outflows for current liabilities are necessary.
7. An increase in the current asset to total asset ratio has the effects of _________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
8. A decrease in the current asset to total asset ratio has the effects of _________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
9. A decrease in the current liabilities to total assets ratio has the effects of _________ on profits and _________ on risk.
(a) an increase; an increase
(b) an increase; a decrease
(c) a decrease; a decrease
(d) a decrease; an increase
10. The aggressive financing strategy results in the firm financing its short-term needs with _________ funds and its long-term
needs with _________ funds.
(a) long-term; short-term
(b) short-term; long-term
(c) permanent; seasonal
(d) seasonal; permanent
Irish 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:
Table 14.1
Drill 2 – Working Capital Management
Current Fixed Total
Month Assets Assets Assets
January $45,000 $100,000 $145,000
February 40,000 100,000 140,000
March 50,000 100,000 150,000
April 55,000 100,000 155,000
May 60,000 100,000 160,000
June 75,000 100,000 175,000
July 75,000 100,000 175,000
August 75,000 100,000 175,000
September 60,000 100,000 160,000
October 55,000 100,000 155,000
November 50,000 100,000 150,000
December 50,000 100,000 150,000
11. The firm’s monthly average permanent funds requirement is (See Table 14.1)
(a) $100,000.
(b) $57,500.
(c) $140,000.
(d) $157,500.
12. The firm’s monthly average seasonal funds requirement is (See Table 14.1)
(a) $17,500.
(b) $57,500.
(c) $40,000.
(d) $157,500.
13. The firm’s annual financing costs of the aggressive financing strategy are (See Table 14.1)
(a) $21,175.
(b) $26,075.
(c) $24,475.
(d) $22,775.
14. The firm’s annual financing costs of conservative financing strategy are (See Table 14.1)
(a) $22,775.
(b) $26,075.
(c) $29,750.
(d) $21,175.
15. The firm’s annual profits on total assets for the previous year were (See Table 14.1)
(a) $20,000.
(b) $21,500.
(c) $23,625.
(d) $25,750.
16. If the firm’s current liabilities in December were $40,000, the net working capital was (See
Table 14.1)
(a) $140,000.
(b) $60,000.
(c) $10,000.
(d) –$10,000.

Table 14.2
Flum Packages, Inc.
Assets Liabilities & Equity
Current assets $10,000 Current Liabilities $ 5,000
Fixed assets 20,000 Long-term debt 12,000
Equity 13,000
Total $30,000 Total $30,000
The company earns 5 percent on current assets and 15 percent on fixed assets. The firm’s current liabilities cost 7 percent to
maintain and the average annual cost of long-term funds is 20 percent.
17. The firm’s initial ratio of current to total asset is _________. (See Table 14.2)
(a) 1:3
(b) 3:1
(c) 2:3
(d) 3:2
18. The firm’s initial net working capital is (See Table 14.2)
(a) –$ 5,000.
(b) $13,000.
(c) $ 5,000.
(d) $10,000.
Drill 2 – Working Capital Management
19. The firm’s initial annual profits on total assets are (See Table 14.2)
(a) $2,500.
(b) $3,500.
(c) $3,000.
(d) $4,500.
20. If the firm was to shift $3,000 of current assets to fixed assets, the firm’s net working capital would _________, the annual
profits on total assets would _________, and the risk of technical insolvency would _________, respectively. (See Table
14.2)
(a) increase; decrease; increase
(b) decrease; increase; decrease
(c) increase; decrease; decrease
(d) decrease; increase; increase
21. If the firm was to shift $7,000 of fixed assets to current assets, the firm’s net working capital would _________, the annual
profits on total assets would _________, and the risk of not being able to meet current obligations would _________,
respectively. (See Table 14.2)
(a) increase; decrease; increase
(b) decrease; increase; decrease
(c) increase; decrease; decrease
(d) decrease; increase; increase
22. If the firm was to shift $2,000 of current liabilities to long-term funds, the firm’s net working capital would _________, the
annual cost of financing would _________, and the risk of technical insolvency would _________, respectively. (See Table
14.2)
(a) decrease; decrease; increase
(b) increase; increase; decrease
(c) decrease; increase; decrease
(d) increase; decrease; decrease
23. The firm would like to increase its current ratio. This goal would be accomplished most profitably by (See Table 14.2)
(a) increasing current liabilities.
(b) decreasing current liabilities.
(c) increasing current assets.
(d) decreasing current assets.
24. In the aggressive financing strategy, a firm anticipating a large increase in sales should finance the increase in working
capital with
(a) the sale of common stock.
(b) the sale of a bond issue.
(c) a line of credit.
(d) a long-term note from the bank.
25. The aggressive financing strategy is risky in two respects: the firm operates with a low level of _________, and the firm
has only a limited amount of _________ capacity.
(a) current liabilities; short-term borrowing
(b) net working capital; short-term borrowing
(c) current assets; long-term borrowing
(d) net working capital; long-term borrowing
26. The conservative financing strategy results in financing all projected funds requirements with _________ funds and use of
_________ funds in the event of an unexpected cash outflow.
(a) long-term; short-term
(b) short-term; long-term
(c) permanent; seasonal
(d) seasonal; permanent
27. In economic conditions characterized by a scarcity of short-term funds, a firm would best choose the _________ financing
strategy.
(a) aggressive
(b) conservative
(c) permanent
(d) seasonal
28. A risk of the _________ financing strategy is unpredictable interest expense.
(a) aggressive
(b) conservative
(c) permanent
(d) seasonal
29. In economic conditions characterized by short-term interest rates which exceed long-term interest rates, the financing
strategy which would maximize profits is _________ strategy.
(a) the aggressive
(b) the conservative
(c) the trade-off
Drill 2 – Working Capital Management
(d) a seasonal
30. An increase in the average payment period will result in _________ in the operating cycle and _________ in the cash
conversion cycle.
(a) an increase; a decrease
(b) a decrease; a decrease
(c) a decrease; no change
(d) no change; a decrease
31. The difference between the number of days resources are tied up in the operating cycle and the number of days the firm can
use spontaneous financing before payment is made is the
(a) cash conversion cycle.
(b) average payment period.
(c) average collection period.
(d) average age of inventory.
Topic: Managing the Cash Conversion Cycle
32. A firm has annual operating outlays of $1,800,000 and a cash conversion cycle of 60 days. If the firm currently pays 12
percent for negotiated financing and reduces its cash conversion cycle to 50 days, the annual savings is
(a) $50,000
(b) $200,000
(c) $ 6,000.
(d) $216,000.
33. A firm has a cash conversion cycle of 60 days. Annual outlays are $12 million and the cost of negotiated financing is 12
percent. If the firm reduces its average age of inventory by 10 days, the annual savings is _________.
(a) $104,000
(b) $144,000
(c) $ 28,800
(d) $40,000
34. Ideally a firm would like to have a
(a) negative operating cycle.
(b) positive operating cycle.
(c) negative cash conversion cycle.
(d) positive cash conversion cycle
35. A firm may have a negative cash conversion cycle if it
(a) carries very little inventory and sells its products on credit.
(b) carries high inventory and sells its products on credit.
(c) carries very little inventory and sells its products for cash.
(d) carries high inventory and sells its products for cash.
40. As part of a union negotiation agreement, the United Clerical Workers Union conceded to be paid every two weeks instead
of every week. A major firm employing hundreds of clerical workers had a weekly payroll of $1,000,000 and the cost of
short-term funds was 12 percent. The effect of this concession was to delay clearing time by one week. Due to the
concession, the firm
(a) realized an annual loss of $120,000.
(b) realized an annual savings of $120,000.
(c) increased its cash cycle.
(d) decreased its cash turnover.
41. By offering credit to customers, the firm may
(a) increase the price of the good to cover its costs.
(b) decrease its investment in accounts receivable.
(c) decrease its investment in accounts payable.
(d) decrease the cost of goods purchased.
42. If a firm gives up the cash discount on goods purchased on credit, the firm should pay the bill
(a) as late as possible.
(b) as soon as possible.
(c) before the credit period ends.
(d) on the last day of the credit period.

43. A firm is offered credit terms of 1/10 net 45 EOM by a major supplier. The firm has determined that it can stretch the credit
period (net period only) by 25 days without damaging its credit standing with the supplier. Assuming the firm needs short-
term financing and can borrow from the bank on a line of credit at an interest rate of 14 percent, the firm should
(a) give up the cash discount and finance the purchase with the line of credit.
(b) give up the cash discount and pay on the 70th day after the date of sale.
(c) take the cash discount and pay on the first day of the cash discount period.
(d) take the cash discount and finance the purchase with the line of credit, the cheaper source of funds.
44. The cost of giving up a cash discount under the terms of sale 1/10 net 60 (assume a 360-day year) is
Drill 2 – Working Capital Management
(a) 7.2 percent.
(b) 6.1 percent.
(c) 14.7 percent.
(d) 12.2 percent.
45. The effective interest rate is
(a) higher on a loan if interest is paid at maturity.
(b) lower if the loan is a discount loan.
(c) higher if the loan is a discount loan.
(d) not affected by whether the loan is a discount loan or a loan with interest paid at maturity.

46. A bank lends a firm $1,000,000 for one year at 12 percent on a discounted basis and requires compensating balances of 10
percent of the face value of the loan. The effective annual interest rate associated with this loan is
(a) 12 percent.
(b) 13.3 percent.
(c) 13.6 percent.
(d) 15.4 percent.

47. Compared to a line of credit, a revolving credit agreement generally will be

(a) a lower cost, higher risk method of short-term borrowing.
(b) a lower cost, lower risk method of short-term borrowing.
(c) a higher cost, higher risk method of short-term borrowing.
(d) a higher cost, lower risk method of short-term borrowing.
48. With a floating-rate note, the interest rate on the note changes
(a) when the risk level of the borrower changes.
(b) when the prime rate changes.
(c) when the demand for loans changes.
(d) when bank profits changes
49. A firm has a line of credit and borrows $25,000 at 9 percent interest for 180 days or half a year. What is the effective rate of
interest on this loan if the interest is paid in advance?
(a) 4.7 percent.
(b) 9.4 percent.
(c) 9.9 percent.
(d) 10.3 percent.
50. Pledges of accounts receivable and factoring of accounts receivable are made on _________ basis, respectively.
(a) a nonrecourse and a notification
(b) a nonnotification and a notification
(c) a notification and a recourse
(d) a notification and a nonrecourse
51. Lenders recognize that by having an interest in collateral they can reduce losses if the borrowing firm defaults,
(a) and the presence of collateral reduces the risk of default.
(b) but the presence of collateral has no impact on the risk of default.
(c) therefore lenders prefer to lend to customers from whom they are able to require collateral.
(d) therefore lenders will impose a higher interest rate on unsecured short-term borrowing.
52. Tangshan Mining issued $1,000,000 of commercial paper for $992,500 for 45 days. Based on this information, the effective
annual rate of interest on the commercial paper would be
(a) 6.13%.
(b) 6.29%.
(c) 6.24%.
(d) 6.08%.
53. Tangshan Mining borrowed $100,000 for one year under a revolving credit agreement that authorized and guaranteed the firm
access to $200,000. The revolving credit agreement had a stated interest rate of 7.5 percent and charged the firm a one
percent commitment fee on the unused portion of the agreement. Based on this information, the effective annual interest
rate on the loan was
(a) 7.5%.
(b) 8.0%.
(c) 8.5%.
(d) 9.0%.
54. Tangshan Mining was extended credit terms of 3/15 net 30 EOM. The cost of giving up the cash discount, assuming payment
would be made on the last day of the credit period, is 75.25 percent. If the firm were able to stretch its accounts payable to
60 days without damaging its credit rating, the cost of giving up the cash discount would only be
Drill 2 – Working Capital Management
(a) 18.81%.
(b) 18.25%.
(c) 21.90%.
(d) 22.58%.
55. Which of the following is NOT an advantage of factoring?
(a) Accounts receivable immediately turned into cash.
(b) Elimination of credit and collection department.
(c) Creation of a known pattern of cash flows.
(d) The effective interest rate.

Table 14.6
Dizzy Animators, Inc. currently makes all sales on credit and offers no cash discount. The firm is considering a 3 percent cash
discount for payment within 10 days. The firm’s current average collection period is 90 days, sales are 400 films per year,
selling price is $25,000 per film, variable cost per film is $18,750 per film, and the average cost per film is $21,000. The
firm expects that the change in credit terms will result in a minor increase in sales of 10 films per year, that 75 percent of
the sales will take the discount, and the average collection period will drop to 30 days. The firm’s bad debt expense is
expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent of sales. The firm’s
required return on equal-risk investments is 20 percent.
56. What is the firm’s marginal profit contribution from sales under the proposed plan of initiating the cash discount? (See
Table 14.6)
(a) $22,500
(b) $40,000
(c) $62,500
(d) $100,000
57. What is the marginal investment in accounts receivable under the proposed plan? (See Table 14.6)
(a) $1,234,375
(b) $1,382,500
(c) $1,567,300
(d) $1,841,570
58. What is the cost of marginal investment in accounts receivable under the proposed plan? (See
Table 14.6)
(a) $313,460
(b) $276,500
(c) $246,875
(d) $368,314
59. What are the savings of marginal bad debts under the proposed plan? (See Table 14.6)
(a) $500,000
(b) $50,000
(c) $10,000
(d) $5,000
60. What is the cost of the marginal cash discount? (See Table 14.6)
(a) $768,750
(b) $300,000
(c) $307,500
(d) $230,625
61. What is the net result of increasing the cash discount? (See Table 14.6)
(a) $33,750
(b) –$33,750
(c) $128,750
(d) –$58,750
62. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying the chemical in
inventory is 50 cents per gallon per year, and the cost of ordering the chemical is $150 per order. The firm uses the
chemical at a constant rate throughout the year. The chemical’s economic order quantity is
(a) 32,863 gallons.
(b) 11,619 gallons.
(c) 9,487 gallons.
(d) 1,900 gallons.
63. A firm is considering relaxing credit standards, which will result in annual sales increasing from $1.5 million to $1.75 million,
the cost of annual sales increasing from $1,000,000 to $1,125,000, and the average collection period increasing from 40 to
55 days. The bad debt loss is expected to increase from 1 percent of sales to 1.5 percent of sales. The firm’s required return
on investments is 20 percent. The firm’s cost of marginal investment in accounts receivable is
(a) $5,556.
(b) $9,943.
(c) $12,153.
(d) $152,778.
Drill 2 – Working Capital Management
64. 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
(a) $10,000.
(b) –$16,250.
(c) –$26,875.
(d) –$16,875.
65. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying the chemical in
inventory is 50 cents per gallon per year, and the cost of ordering the chemical is $150 per order. The firm uses the
chemical at a constant rate throughout the year. It takes 18 days to receive an order once it is placed. The reorder point is
(a) 7,500 gallons.
(b) 25,000 gallons.
(c) 90,000 gallons.
(d) 105,000 gallons
66. Among solutions to the agency problem in publicly-held corporations are all of the following EXCEPT
(a) stock options.
(b) performance shares.
(c) cash bonuses tied to goal achievement.
(d) bonuses based on short term results
67. Securities exchanges create efficient markets that do all of the following EXCEPT
(a) ensure a market in which the price reflects the true value of the security.
(b) allocate funds to the most productive uses.
(c) control the supply and demand for securities through price.
(d) allow the price to be determined by supply and demand of securities.
68. The financial manager is interested in the cash inflows and outflows of the firm, rather than the accounting data, in order to
ensure
(a) profitability.
(b) the ability to pay dividends.
(c) the ability to acquire new assets.
(d) solvency.
69. Economic theories that the financial manager must be able to utilize for efficient business operations, include
(a) supply and demand analysis.
(b) marginal analysis.
(c) profit maximizing strategies.
(d) price theory.
(e) all of the above.
70. The primary economic principle used in managerial finance is
(a) supply and demand.
(b) the liquidity trap.
(c) the crowding out effect.
(d) marginal analysis.