If a firm increases its cash balance by issuing additional shares of common stock, net working capital
Answer (D) is correct. Net working capital is the excess of current assets over current liabilities. The current ratio equals current assets divided by current liabilities. Selling stock for cash increases current assets and stockholders’ equity, with no effect on current liabilities. The result is an increase in working capital and the current ratio.
Starrs Company has current assets of $400,000 and current liabilities of $300,000. Starrs could increase its net working capital by the
Answer (B) is correct. Net working capital is defined as the excess of current assets over current liabilities. Refinancing short-term debt with long-term debt decreases current liabilities with no effect on current assets, resulting in an increase in working capital.
The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s maturing obligations is the policy that finances
Answer (C) is correct. Fluctuating current assets can often be financed with short-term debt because the periodic liquidation of the assets provides funds to pay off the debt. However, financing permanent current assets with short-term debt is a risky strategy because the assets may not be liquidated in time to pay off the debt at maturity.
Clay Corporation follows an aggressive financing policy in its working capital management while Lott Corporation follows a conservative financing policy. Which one of the following statements is correct?
Answer (B) is correct. A conservative working capital management financing policy uses permanent capital to finance permanent asset requirements and also some or all of the firm’s seasonal demands. Thus, Lott’s current ratio (current assets/current liabilities will be high since its current liabilities will be relatively low. An aggressive policy entails financing some fixed assets and all the current assets with short-term capital. This policy results in a lower current ratio.
Which of the following is not a function of financial management?
(c) The requirement is to identify the function that is
not related to financial management. The correct answer is (c)
because internal control is a function of the controller’s office.
Answers (a), (b), and (d) are incorrect because the functions of
financial management include: financing, capital, budgeting,
financial management, corporate governance, and risk management.
All of the following statements in regard to working capital
are correct except:
(d) The requirement is to determine the false statement
regarding working capital management. Answer (d) is correct
because financing permanent inventory buildup with long-term
debt is an example of a conservative working capital policy. Answers
(a), (b), and (c) are all accurate statements about working
Determining the appropriate level of working capital for a
(d) The requirement is to identify the factor considered
in determining the appropriate level of working capital. Answer
(d) is correct because the main reason to retain working
capital is to meet the firm’s financial obligations. Therefore, the
amount is determined by offsetting the benefit of current assets
and current liabilities against the probability of technical insolvency.
Answer (a) is incorrect because it is a consideration regarding
long-term financing. Answer (b) is incorrect because it is
a consideration regarding capital structure. Answer (c) is incorrect
because short-term debt is generally less expensive than
Which of the following actions is likely to reduce the length
of a firm’s cash conversion cycle?
(a) The requirement is to identify the impact of decisions
on the cash conversion cycle. The cash conversion cycle is
equal to the Inventory conversion period + Receivables collection
period – Payables deferral period. Answer (a) is correct
because the impact of a decreased inventory conversion period is
a reduction in the cash conversion cycle. Answers (b), (c), and
(d) are incorrect because these actions would increase the length
of a firm’s cash conversion cycle.
Eagle Sporting Goods has $2.5 million in inventory and $2
million in accounts receivable. Its average daily sales are
$100,000. The firm’s payables deferral period is 30 days and
average daily cost of sales are $50,000. What is the length of the
firm’s cash conversion period?
(d) The requirement is to calculate the cash conversion
cycle. The cash conversion period is calculated as the Inventory
conversion period + Receivables collection period – Payables
deferral period. Answer (d) is correct because the inventory
conversion period is $2,500,000/$50,000 = 50 days, and the
receivable conversion period is $2,000,000/$100,000 = 20 days.
Therefore, the cash conversion cycle is equal to 50 days + 20 days
– 30 days = 40 days. Answer (a) is incorrect because is
erroneously adds the payable deferral period.
Jones Company has $5,000,000 of average inventory and
cost of sales of $30,000,000. Using a 365-day year, calculate the
firm’s inventory conversion period.
(b) The requirement is to calculate the inventory
conversion period. The inventory conversion period is calculated
as average inventory/(cost of sales per day). Answer (b) is
correct because $5,000,000/($30,000,000/365) = 60.83 days.