Practice Question LV1 - 2 Flashcards
A U.S. Treasury bill sells for $990 with 90 days remaining to maturity. Its face value is equal to $1,000.
Which of the following methods most likely results in the highest yield?
A. Bond equivalent yield
B. Discount-basis yield
C. Monet market yield
Which of the following combinations would result in an increase in the operating cycle and a decrease in
the cash conversion cycle?
Operating cycle ↑ Cash conversion cycle ↓
A. Increase in receivables turnover ratio A decrease in payables turnover
B. A decrease in the inventory turnover ratio Increase in payables turnover
C. A decrease in the inventory turnover ratio A decrease in payables turnover
Answer: C
A decrease in inventory turnover ratio results in a higher number of days of inventory which in turn
increases the operating cycle. When the payables turnover decreases, the average days of payables
increases. This causes the cash conversion cycle to decrease. Therefore, statement C is the right answer.
Which of the following statements about the aging schedule is least likely accurate?
A. It requires more information compared to calculating the average days of receivables
B. It categorizes accounts by the number of days since they have been paid
C. Analysis of the historical trends provides a clearer picture of what drives changes in the accounts
receivable
Answer: B
Both statements A and C are accurate. The primary drawback of the aging schedule and the weighted
average collection period is that they require more information than the number of days of receivables.
In most cases, this information is difficult to obtain. Nevertheless, analysis of the historical trends of
both measures provides a clearer picture of what drives changes that occur in the accounts receivable.
Thus, the simple metric of average days of receivables is insufficient. Statement B is wrong. The aging
schedule categorizes accounts by the number of days they have been on the firm’s books.
Which of the following statements about inventory management is most likely accurate?
A. An increase in the average days of inventory can indicate that the inventory is too large
B. A large inventory is beneficial for any company because it means there’s enough stock to
compensate for a potential demand increase
C. The average days of inventory of a company in the manufacturing industry should be similar to
that of a firm in the grocery business
Answer: A
This question is a bit tricky. Sometimes companies change their business model which affects the
average days of inventory. Nevertheless, in general, when the average days of inventory increase, while
the turnover ratio decreases, this should be a warning sign. Statement B is wrong. It is true that some
firms may hold inventory because of factors such as seasonality in demand. Nevertheless, large
inventory levels could also lead to greater losses from obsolete items that are included in the book value
but are not expected to sell in the future. Statement C is not accurate, either. The average days of
inventory and inventory turnover differ for companies operating in different industries. For example,
machinery and chemical manufacturing companies typically have high number of inventory days
because it takes longer to realize their production. On the other spectrum, we have the food, beverage
and liquor stores that sell their production quickly. As a result, their inventory turnover is high which
indicates that the processing period is low.
Imagine that company X uses trade credit with terms 3/10 net 60. What would be the effective
borrowing cost when a given invoice is paid on the 60th day?
A. 24.6%
B. 26.8%
C. 24.9%
- Total revenue is greatest for a demand curve that is:
A. elastic.
B. inelastic.
C. unit elastic.
Answer C:
When we talk about revenue, its highest point is where demand elasticity is unit elastic or equals -1.
When the demand curve is elastic, total revenue increases, and when the demand curve is inelastic,
total revenue decreases.
- Let’s say that the demand function for cars is given by the following equation:
QDcars = 15,000 – 0.3Price(cars) + 0.01Income + 3Price(bicycles) – 4Price(tyres)
With current average prices, cars cost 18,000 dollars, bicycles cost 1,000 dollars, and car tires cost 1,000 dollars. The average income is equal to 40,000 dollars. The income elasticity of demand for cars is
closest to:
A. 0.0004.
B. 0.0444.
C. 44
Answer B:
First, we have:
Price(cars)=18,000 dollars
Price(bicycles)=1,000 dollars
Price(tyres)=1,000 dollars
Income elasticity is equal to delta Q divided by delta I, all of this is multiplied by income over quantity.
So, if we calculate the demand function with the information we have, we will end up with the following equation: QDcars=8,600+0.01 Income. Average income = 40,000 =>QDcars = 8,600+0.01x40,000= 8,600+400 = 9,000.
Income elasticity= 0.01(Income/Quantity) = 0.01(40,000/9,000)=0.0444
- When a good’s price decreases, and consumption of that good increases, it is most likely that the:
A. income effect and substitution effect are both positive.
B. substitution effect is negative, and the income effect is positive.
C. income effect is negative, and the substitution effect is positive.
Answer A:
The income effect and the substitution effect are both positive. It is possible that the demand for a
product increases when the income effect is negative, but in this case, the substitution effect needs to
be greater than the income effect.
- Which of the following statements is true for “a normal good”:
A. Its income elasticity is positive.
B. Its own-price elasticity is positive.
C. Its cross-price elasticity is positive.
Answer A. Whether a good is considered normal or inferior is determined by its income elasticity. When the
income elasticity is positive, the good is normal and when the income elasticity is negative, we say that
the good is inferior.
- Which of the following statements is true for a “complimentary good”:
A. Its income elasticity is negative.
B. Its cross-price elasticity is negative.
C. Its own-price elasticity is positive
Answer B:
If the cross-price elasticity is negative, we have complementary goods, and if the cross-price elasticity is
positive, we have substitute products.
- A good is classified as a substitute if its:
A. income elasticity is negative.
B. cross-price elasticity is positive.
C. own-price elasticity is positive.
Answer B:
If the cross-price elasticity is negative, we have complementary goods and if the cross-price elasticity is
positive, we have substitute products.
- A firm’s average revenue is less than its average variable cost and less
than its average total cost. If this situation is expected to persist, the firm
should:
A. shut down in the short run and in the long run.
B. shut down in the short run but operate in the long run.
C. operate in the short run but shut down in the long run
Answer A:
When a firm’s average revenue is lower than its average variable costs, continuing to run the business
will increase the losses incurred.
- If a firm’s long-run average total cost decreases by 6% and its output increases by 6%, the firm is
experiencing:
A. economies of scale
B. diseconomies of scale
C. constant returns to scale
Answer A:
When the output increases but the average total costs decrease, there are economies of scale. On the other hand, when both output and average total costs increase, there are diseconomies of scale.
- What could be a possible reason for the diseconomies of scale?
A. a principal-agent problem
B. discounted prices
C. the division of labor
Answer A:
Diseconomies of scale are usually due to the principal-agent problem, lack of communication, and
additional management costs. This problem often occurs in large organizations when the workload is
delegated to employees who are less committed to excellent performance than the owner is.
- When managers make decisions that will benefit them, but not the stockholders, this is called:
A. shirking problem
B. principal-agent problem
C. asymmetric benefits problem
Answer B:
The principal-agent problem often occurs in large organizations when the workload is delegated to
employees who are less committed to excellent performance than the owner is. In such cases, managers often make decisions that serve their own interests, rather than the interests of stockholders.
- According to the law of diminishing marginal returns, if the marginal product is negative:
A. adding one more employee will increase production
B. adding one more employee will decrease production
C. adding one more employee does not affect the production
Answer B:
The law of diminishing marginal returns states that, at some point, increasing the factors of production
results in smaller increases in output.
- Which of the following statements regarding economic costs is most accurate?
A. Fixed costs must be considered only in the long run when companies decide whether to continue
their operations.
B. Average variable costs are the most relevant costs for the company in the long run.
C. For an additional unit of output to be profitable, its marginal revenue must be at least as great as the
expected average variable cost.
Answer A:
Fixed costs must be considered only in the long run when companies decide whether to continue their
operations. Fixed costs can be changed in the long run only.
- How does a long-run decision to operate differ from a short-run decision?
A. Both variable and fixed costs can be changed in the short run.
B. Only fixed costs can be changed in the short run.
C. Only variable costs can be changed in the short run.
Answer C:
Fixed costs can be changed in the long run and variable costs can be changed both in the short run and
in the long run.
- How does a long-run decision to operate differ from a short-run decision?
A. Both variable and fixed costs can be changed in the short run.
B. Only fixed costs can be changed in the short run.
C. Only variable costs can be changed in the short run.
Answer C:
Fixed costs can be changed in the long run and variable costs can be changed both in the short run and
in the long run.
