M5-Working Capital Management: Part 2

Question 1

Float is the difference between the balance of checks outstanding, which have not cleared the bank and deposits made but which have not yet cleared the bank here. (true or false)

Answer 1

true

Question 2

Matching the maturities of current assets with liabilities as they come due is designed to ensure liquidity and reduce risk of cash shortages. Temporary assets (such as inventories, generally, and seasonal inventories, specifically) might be financed with short term debt such that earnings from the sales of those temporary assets could be used to liquidate the related obligations as they come due and ensure that cash is available to meet cash flow requirements. (true or false)

Answer 2

true

Question 3

A lockbox system expedites cash inflows (minimizes collection float) by having a bank receive payments from a company’s customers directly, via mailboxes to which the bank has access. Payments that arrive in these mailboxes are deposited into the company’s account immediately. (true or false)

Answer 3

true

Question 4

Concentration banking is the method by which a single bank is designated as a central bank as a means of controlling receipts. (true or false)

Answer 4

true

Question 5

The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is to reduce the coupon rate on NEW bonds being sold. (true or false)

Answer 5

true

A debt covenant is a provision in a bond indenture (contract between the bond issuer and the bond holders) that the bond issuer will either do (affirmative covenants) or not do (negative covenants) certain things.

In this question, the issuer would agree not to issue bonds in the future over a certain percentage of its long-term debt. Such a provision would be good for the potential bondholders and would probably reduce the coupon rate on the bonds being sold.

Question 6

The following are methods of converting accounts receivable (AR) into cash:

Answer 6

1. Collection Agencies- used to collect overdue AR
2. Factoring AR-selling AR to a factor for cash
3. Cash discounts-offering cash discount to customer for paying AR quickly (or paying at all). For example 2/10, net 30.
4. Electronic fund transfers- a method of payment, which electronically transfers funds between banks.

Trade discounts offer discounts on future merchandise purchases offered to trade customers. These discounts do not turn AR into cash.

Question 7

There are 3 primary motives for holding cash:

Answer 7

1. Transaction Demand - maintain adequate cash needed for transactions
2. Precautionary demand - maintain a precautionary balance
3. Speculative demand - satisfy compensating balance requirements

However, cash is generally held in very short-term liquid investments which are low risk, low return.