Answer (A) is correct. Net working capital is defined by accountants as the difference between current assets and current liabilities. Working capital is a measure of short-term solvency.
Answer (C) is correct. Working capital finance concerns the determination of the optimal level, mix, and use of current assets and current liabilities. The objective is to minimize the cost of maintaining liquidity while guarding against the possibility of technical insolvency. Technical insolvency is defined as the inability to pay debts as they come due.
Answer (D) is correct. A company must maintain a level of working capital sufficient to pay bills as they come due. Failure to do so is technical insolvency and can result in involuntary bankruptcy. Unfortunately, holding current assets for purposes of paying bills is not profitable for a company because they usually offer a low return compared with longer-term investments. Thus, the skillful management of working capital requires a balancing of a firm’s desire for profit with its need for adequate liquidity.
Answer (D) is correct. Financing permanent inventory buildup, which is essentially a long-term investment, with long-term debt is a moderate or conservative working capital policy. An aggressive policy involves using short-term, relatively low-cost debt to finance the inventory buildup. It focuses on high profitability potential, despite high risk and low liquidity. An aggressive policy involves reducing liquidity and accepting a higher risk of short-term lack of liquidity. Financing inventory with long-term debt increases the current ratio and accepts higher borrowing costs in exchange for greater liquidity and lower risk.
Answer (D) is correct. Net working capital is the excess of current assets over current liabilities. An increase in current assets or a decrease in current liabilities increases working capital. Thus, net working capital increased by $170,000 ($120,000 + $50,000 .
Answer (A) is correct. Net working capital is the excess of current assets over current liabilities. An increase in current assets or a decrease in current liabilities will increase net working capital. Option 1 maximizes Mason Company’s net working capital, increasing it by $170 ($120 + $50).
Answer (D) is correct. Net working capital equals current assets minus current liabilities. Refinancing a short-term note with a 2-year note payable decreases current liabilities, thus increasing working capital.
Answer (B) is correct.When a firm has an aggressive working capital policy, management keeps the investment in working capital at a minimum. Thus, a growing company would want to invest its funds in capital goods and not in idle assets. This policy maximizes return on investment at the price of the risk of minimal liquidity.
Answer (C) is correct. A conservative working capital policy minimizes liquidity risk by increasing net working capital (current assets – current liabilities). The result is that the company forgoes the potentially higher returns available from using the additional working capital to acquire long-term assets. A conservative working capital policy is characterized by a higher current ratio (current assets ÷ current liabilities) and acid test ratio (quick assets ÷ current liabilities). Thus, the company will increase current assets or decrease current liabilities. A conservative policy finances assets using long-term or permanent funds rather than short-term sources.
Answer (D) is correct. A conservative working capital policy results in an increase in working capital (current assets – current liabilities). It is typified by a reduction in liquidity risk. Increasing the current ratio, whether by decreasing current liabilities or increasing current assets, minimizes the risk that the company will not be able to meet its obligations as they fall due. Thus, an increasing ratio of current to noncurrent assets means that a company is forgoing the potentially higher returns on long-term assets in order to guard against short-term cash flow problems.
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