Midterm Examination MCQ Flashcards
ABC Corp. has experienced increasing sales but faces liquidity problems due to slow collection from customers. Which working capital policy should ABC Corp. adopt to address this issue?
a. Increase investment in inventory to meet growing demand.
b. Extend more generous credit terms to customers.
c. Implement stricter credit policies and improve collection efforts.
d. Reduce accounts payable to strengthen supplier relationships.
ANS: Implement stricter credit policies and improve collection efforts.
BASIS: Stricter credit policies help improve cash flow by ensuring faster collection from customers, reducing liquidity issues. (Investopedia)
XYZ Corp. operates a seasonal business with fluctuating cash flows. Which of the following strategies would be most appropriate?
a. Maintain a high level of cash reserves at all times.
b. Use short-term borrowing during off-seasons and repay during peak seasons.
c. Avoid using credit and rely only on cash reserves.
d. Invest in long-term securities for better returns.
ANS: Use short-term borrowing during off-seasons and repay during peak seasons.
BASIS: Short-term borrowing aligns with seasonal fluctuations, ensuring liquidity without excessive cash reserves. (Corporate Finance Institute)
XYZ Corp. invests in marketable securities to manage excess cash. What is the main risk if the company needs to sell them quickly?
a. The company will generate excess profits.
b. The company may incur losses due to price fluctuations.
c. The company’s credit rating will improve.
d. The company will lose access to short-term financing.
ANS: The company may incur losses due to price fluctuations.
BASIS: Marketable securities are subject to market volatility, which can lead to losses if sold under unfavorable conditions. (Investopedia)
ABC Corp. has excess cash for 6 months and is choosing between certificates of deposit (CDs) and commercial paper. If liquidity is a priority, which is the better choice?
a. Commercial paper.
b. Certificates of deposit (CDs).
c. Common stock.
d. Real estate investment.
ANS: Commercial paper.
BASIS: Commercial paper offers higher liquidity and short-term flexibility compared to CDs, which have fixed maturity periods. (Financial Times)
A company is experiencing an increasing average collection period due to late customer payments. Which action would be the most effective solution?
a. Offer cash discounts for early payments.
b. Increase the credit period for customers.
c. Extend credit to more customers.
d. Reduce advertising expenses.
ANS: Offer cash discounts for early payments.
BASIS: Cash discounts incentivize faster payments, reducing the average collection period and improving cash flow. (Harvard Business Review)
XYZ Corp. has high inventory levels and slow receivables collection. How might this impact the company’s profitability?
a. Increase net profit by reducing tax liability.
b. Decrease profitability due to high carrying costs.
c. Improve return on investment (ROI).
d. Reduce financial risk and improve liquidity.
ANS: Decrease profitability due to high carrying costs.
BASIS: Excess inventory increases storage costs and ties up capital, negatively affecting profitability. (Corporate Finance Institute)
ABC Company needs to balance liquidity and profitability in its cash management. Which of the following is the best approach?
a. Keep all cash in a checking account for easy access.
b. Invest all excess cash in high-return, long-term assets.
c. Maintain a buffer cash reserve while investing excess funds in liquid securities.
d. Borrow short-term funds instead of holding cash.
ANS: Maintain a buffer cash reserve while investing excess funds in liquid securities.
BASIS: A balanced approach ensures sufficient liquidity while optimizing returns on excess funds. (McKinsey & Company)
ABC Corp. wants to reduce its collection float. Which of the following would be the best approach?
a. Delay payments to suppliers.
b. Use electronic funds transfer (EFT) for customer payments.
c. Invest excess cash in long-term securities.
d. Increase credit terms to customers.
ANS: Use electronic funds transfer (EFT) for customer payments.
BASIS: EFT speeds up the collection process, reducing collection float and improving cash flow. (Corporate Finance Institute)
A company is deciding between commercial paper and U.S. Treasury bills to invest excess cash. If safety and liquidity are the top priorities, which option is better?
a. Commercial paper.
b. U.S. Treasury bills.
c. Corporate bonds.
d. Preferred stock.
ANS: U.S. Treasury bills.
BASIS: Treasury bills are backed by the U.S. government, offering the highest level of safety and liquidity. (Federal Reserve)
XYZ Corp. has $2 million in surplus cash that it does not need for 3 months. Which investment option would maximize returns while ensuring liquidity?
a. Long-term municipal bonds.
b. Common stock investments.
c. 90-day Treasury bills.
d. Real estate.
ANS: 90-day Treasury bills.
BASIS: Short-term Treasury bills provide a secure investment with predictable returns and high liquidity. (Investopedia)
**A company is evaluating two financing options for its working capital needs:
Option A: Short-term bank loan at 7% interest.
Option B: Long-term debt at 9% interest.
Which option is more appropriate if the company needs financing for seasonal working capital fluctuations?
a. Option A: Short-term bank loan.
b. Option B: Long-term debt.
c. Use retained earnings instead.
d. Issue common stock.
ANS: Option A: Short-term bank loan.
BASIS: Short-term loans are better suited for temporary financing needs, such as seasonal working capital fluctuations, as they offer flexibility and lower interest rates than long-term debt. (Corporate Finance Institute)
XYZ Corp. receives customer payments from across the country. Currently, it takes an average of 5 days for checks to clear. If they implement a lockbox system, clearing time is expected to reduce to 2 days. What is the primary benefit of this system?
a. Increase sales revenue.
b. Reduce bad debt expenses.
c. Improve cash flow and reduce float time.
d. Increase profit margins.
ANS: Improve cash flow and reduce float time.
BASIS: A lockbox system speeds up the collection process by reducing check clearing time, improving cash availability, and minimizing collection float. (Investopedia)
A company has $500,000 in excess cash that will not be needed for six months. Which of the following would be the most appropriate investment?
a. Corporate bonds maturing in 5 years.
b. Common stock of a high-growth tech company.
c. Treasury bills with a 6-month maturity.
d. Retaining cash in a checking account.
ANS: Treasury bills with a 6-month maturity.
BASIS: Treasury bills are low-risk, short-term investments that match the company’s six-month timeframe, ensuring both liquidity and security. (U.S. Treasury)
A company wants to invest in marketable securities that maximize returns but still provide some liquidity. Which of the following is the best choice?
a. Money market funds.
b. Long-term corporate bonds.
c. Certificates of deposit (CDs) with a 3-year maturity.
d. High-yield stocks.
ANS: a. Money market funds.
BASIS: Money market funds offer a balance between liquidity and returns. They invest in short-term, high-quality securities, allowing the company to access funds quickly while earning modest returns. In contrast, long-term corporate bonds and 3-year CDs tie up funds for longer periods, reducing liquidity. High-yield stocks are more volatile and not as liquid as money market instruments. (Corporate Finance Institute)
Funds that have been sent by the payer but are not yet usable funds to the payee area.
a. Float
b. Overdrawn funds
c. Still available for the use of the payer
d. None of these
ANS: a. Float
BASIS: “Float” refers to the period when funds have been transferred but are not yet available to the recipient. This can happen due to processing times in banking systems.
The short-term financing strategy where a company relies heavily on short-term borrowing to finance a portion of their long-term growth is called a(n):
a. Conservative strategy
b. Aggressive strategy
c. Matching strategy
d. Growth strategy
ANS: b. Aggressive strategy
BASIS: An aggressive financing strategy involves using short-term debt to finance part of long-term assets, which increases risk but may offer cost savings compared to long-term financing.
Which of the following statements is NOT CORRECT?
a. A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year.
b. Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected.
c. The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans.
d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
e. Managing working capital is important because it influences financing decisions and the firm’s profitability.
ANS: d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
BASIS: Extending the credit period from 2/10, net 30 to net 60 delays cash inflows, reducing short-term cash flow rather than increasing it. A firm looking to improve cash flow quickly would instead tighten credit terms to encourage faster collections. (Investopedia)
Which of the following statements is CORRECT?
a. Other things held constant, the higher a firm’s days sales outstanding (DSO), the better its credit department.
b. If a firm that sells on terms of net 30 changes its policy to 2/10, net 30, and if no change in sales volume occurs, then the firm’s DSO will probably increase.
c. If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then the firm probably has some past due accounts.
d. If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in January than in July.
e. If a firm changed the credit terms offered to its customers from 2/10, net 30 to 2/10, net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the DSO.
ANS: c. If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then the firm probably has some past due accounts.
BASIS: Days Sales Outstanding (DSO) represents the average time it takes for a company to collect payments. If a firm offers a 2/10, net 30 term, customers should ideally pay within 10 days to get the discount. If the firm’s DSO is exactly 30 days, it suggests that some customers are delaying payments beyond the discount period, possibly indicating past due accounts. (Corporate Finance Institute)
Which of the following statements is CORRECT?
a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
b. In managing a firm’s accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
ANS: b. In managing a firm’s accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
BASIS: If a company increases its credit sales but collects payments faster (reducing DSO), then the total amount of accounts receivable does not necessarily increase. Efficient credit management ensures that even with higher sales, receivables remain controlled. (Corporate Finance Institute)
Which of the following is NOT commonly regarded as being a credit policy variable?
a. Credit period.
b. Collection policy.
c. Credit standards.
d. Cash discounts.
e. Payments deferral period.
ANS: e. Payments deferral period.
BASIS: A credit policy typically includes variables such as the credit period, collection policy, credit standards, and cash discounts, all of which define how a firm manages credit sales and collections. The “payments deferral period” usually refers to how long a company delays its own payments (accounts payable), which is a liability management strategy rather than a direct credit policy variable. (Investopedia)
A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in the amount of bad debts, and a decrease in the investment in accounts receivable. Based upon this information, the company’s
a. Average collection period has decreased
b. Percentage discount offered has decreased
c. Accounts receivable turnover has decreased
d. Working capital has increased
ANS: a. Average collection period has decreased.
BASIS: A reduction in the investment in accounts receivable suggests that customers are paying more quickly, which means the average collection period has decreased. Additionally, an increase in discounts taken implies customers are taking advantage of early payment incentives, further reducing the collection period. (Corporate Finance Institute)
Suppose a firm experiences a seasonal pattern in its sales, in addition to a long-term upward trend. Which of the following financing plans has the potential to be less costly to the firm?
a. A conservative strategy
b. An aggressive strategy
c. A matching strategy
d. They are equally likely to be low-cost
ANS: c. A matching strategy.
BASIS: A matching strategy aligns financing sources with asset duration, ensuring that seasonal fluctuations are covered by short-term financing while long-term growth is funded by long-term financing, optimizing costs. (Corporate Finance Institute)
The amount of time that it takes for a check to clear through the banking system is called
a. Mail float
b. Processing float
c. Clearing float
d. Delivery float
ANS: c. Clearing float.
BASIS: Clearing float represents the period between when a check is deposited and when the funds become available, affecting a firm’s cash flow management. (Investopedia)
Special post office boxes set up by the firm to expedite the receipt and processing of its accounts receivables are called
a. Safety-deposit boxes
b. Lockboxes
c. Float reducer
d. None of these
ANS: b. Lockboxes.
BASIS: Lockbox systems accelerate cash collections by reducing mail and processing float, allowing firms to access funds more quickly. (Corporate Treasury Management)
