Working capital management

Question 1

what is the objective of working capital finance

Answer 1

to minimize the cost of maintaining liquidity while guarding against the risk of insolvency

Question 2

Working capital policy applies to long-term decisions. True or false

Answer 2

False

working capital policy applies to short-term decisions; capital structure finance applies to long-term decisions

Question 3

permanent working capital is

Answer 3

the minimum level of current assets maintained by a firm

should increase as the firm grows

generally is financed with long-term debt

Question 4

a firm that adopts a conservative working capital policy seeks to

Answer 4

minimize liquidity risk by increasing working capital

forgoes the potentially higher returns from investing in long-term assets

reflected in a higher current ratio

Question 5

a firm that adopts an aggressive working capital policy seeks to

Answer 5

increase profitability while accepting liquidity and a higher risk of short-term cash flow problems

lower current ratio

Question 6

three motives for holding cash

Answer 6

1. transactional (as a medium of exchange)
2. precautionary (to provide a reserve for contingencies)
3. speculative (to take advantage of unexpected opportunities)

Question 7

what is cash float

Answer 7

the period from when a payor mails a check until the funds are available in the payee’s bank

Question 8

strategies to decrease float time for receipts

Answer 8

-lock box system
-concentration banking

Question 9

annual benefit of speeding up cash collections

Answer 9

(daily cash receipts x days of reduced float) x opportunity cost of funds

Question 10

disbursement float

Answer 10

the period from when the payor writes a check until the funds clear and are deducted from the payor’s account

Question 11

what is a compensating balance

Answer 11

the minimum amount that a bank requires to keep frozen in its account

incur opportunity costs because they are unavailable for investment purposes

Question 12

strategies for managing cash outflows

Answer 12

-overdraft protection
-zero balance accounts
-centralizing accounts payable
-controlled disbursement accounts

Question 13

what are the most important aspects of marketable securities management?

Answer 13

-achieving an optimal risk and after-tax return trade-off
-liquidity
-safety

Question 14

increased investment in receivables formual

Answer 14

incremental variable costs x (incremental average collection period / days in year)

Question 15

cost of a change in credit terms formula

Answer 15

increased investment in receivables x opportunity cost of funds

Question 16

the benefit or loss resulting from a change in credit terms calculation

Answer 16

incremental contribution margin - cost of change

Question 17

the _____ limit of a company’s credit period is the operating cycle of the purchaser

Answer 17

upper

if the credit period is longer than the purchaser’s operating cycle, the seller is financing more than just the purchaser’s inventory needs

Question 18

what are the four components of costs related to inventory

Answer 18

1. purchase costs (actual invoice amounts charged by suppliers or the investment in inventory)
2. carrying costs (includes the opportunity cost of funds invested in inventory)
3. ordering costs (cost of placing an order with a vendor)
4. stockout costs (the opportunity cost of missing a customer order)

Question 19

maintaining safety stock increases carrying costs. True or false

Answer 19

True

Question 20

what are the two components of the total cost of carrying safety stock

Answer 20

expected stockout costs + carrying cost

Question 21

economic order quantity (EOQ) model

Answer 21

a mathematical means of determining the order quantity.

minimizes the sum of ordering costs and carrying costs

Question 22

how changes in variables affect the EOQ solution

Answer 22

Question 23

assumptions of the EOQ model

Answer 23

-demand is uniform
-carrying costs are constant
-the same quantity is ordered at each reorder point
-purchasing costs are unaffected by the quantity ordered
-sales are perfectly predictable
-lead time is known with certainty
-deliveries are consistent
-adequate inventory is maintained to avoid stockouts

Question 24

What are statements that characterize U.S. Treasury bills

Answer 24

-they have no coupon rate because they are sold at a discount
-they are backed by the full faith and credit of the United States government, so there is not default risk
-the interest received is subject to federal income tax

Question 25

The level of safety stock in inventory management depends on:

Answer 25

-level of customer dissatisfaction for back orders
-level of uncertainty of the sales forecast
-cost of running out of inventory

Question 26

Average daily collection of checks for a firm is $40,000. The firm also writes on the average $35,000 of checks daily. If the collection period for checks is 5 days, calculate the net float

Answer 26

$25,000

the difference between the collections and payables is $5,000 daily. Five days’ worth amounts to $25,000 of float

Question 27

The optimal level of inventory is affected by what factors?

Answer 27

-the periodic demand for inventory
-the carrying cost, which includes the interest on funds invested in inventory
-the usage rate
-the cost of placing an order or making a production run