Question 1

The cash conversion cycle is equal to the days of sales outstanding plus the days of sales in inventory plus the days of payables outstanding.

Accepted Answer

The cash conversion cycle is equal to the days of sales outstanding plus the days of sales in inventory minus the days of payables outstanding.

Question 2

Which of the following is most likely to be a temporary source of financing?

Accepted Answer

Commercial paper is a type of short-term borrowing that is usually issued by large corporations and financial institutions. It typically has a maturity of up to 270 days and is often used to finance short-term working capital needs, such as inventory purchases or accounts payable. As such, commercial paper is a temporary source of financing that is meant to be repaid within a relatively short period of time. Preferred stock, long-term debt, and common stock, on the other hand, are all examples of long-term financing sources.

Question 3

Trade credit is an example of which of the following sources of financing?

Accepted Answer

Trade credit is a type of spontaneous financing, which refers to the funding that arises naturally from the company's operations, such as accounts payable or accrued expenses. It is a form of financing that a firm receives when it buys goods or services on credit from its suppliers and pays for them later. Therefore, trade credit is not a permanent or discretionary source of financing but a short-term and spontaneous one, linked to the purchase and sale of goods and services between firms.

Question 4

The cash conversion cycle is a measure of a firm's effectiveness in managing its working capital.

Accepted Answer

The cash conversion cycle (CCC) measures the amount of time it takes a firm to convert its investments in inventory and other resources into cash flow from sales. Therefore, it is a metric used to evaluate a company's efficiency in managing its current assets and liabilities, and it is an important indicator of a business's financial health.

Question 5

If a company's inventory turnover increases from 8 to 10,then its cash conversion cycle will also increase,i.e.,get longer.

Accepted Answer

A higher inventory turnover indicates that the company is selling its inventory more quickly, resulting in a shorter cash conversion cycle. Therefore, if the inventory turnover increases from 8 to 10, the cash conversion cycle would actually decrease or get shorter, not longer.

Question 6

Simpson Conglomerates borrows $12,000 for a short-term purpose.The loan will be repaid after 120 days,with Simpson paying a total of $12,400.What is the approximate cost of credit using the APR,or annual percentage rate,calculation?

Accepted Answer

The answer of Simpson Conglomerates borrows $12,000 for a short-term...

Question 7

If a company offers a cash discount for early payment,this will most likely increase its cash conversion cycle since it will have to pay out more cash to its customers.

Accepted Answer

Offering a cash discount for early payment incentivizes customers to pay their bills sooner, which can decrease the amount of time it takes for the company to collect cash. This would result in a shorter cash conversion cycle.

Question 8

What are some examples of permanent and temporary investments in current assets?

Accepted Answer

The answer of What are some examples of permanent and...

Question 9

Simpson Conglomerates borrows $12,000 for a short-term purpose.The loan will be repaid after 120 days,with Simpson paying a total of $12,400.What is the approximate cost of credit using the APY,or annual percentage yield,calculation?

Accepted Answer

The cost of credit can be calculated using the formula for APY, which is: APY = (1 + r/n)^n - 1, where r is the interest rate per period, and n is the number of periods. However, for a simple approximation suitable for this question, we can use a simpler approach: Interest Paid / Principal Amount = (12400 - 12000) / 12000 = 400 / 12000 = 0.0333 or 3.33% for 120 days. To annualize this rate (since APY is an annual rate), we multiply by the number of periods in a year (365/120 = 3.04166). So, 3.33% * 3.04166 ≈ 10.13%, which is closest to option B, 10.34%. The slight difference is due to rounding and the approximation method used.

Question 10

Compounding effectively raises the cost of short-term credit.

Accepted Answer

Compounding means that interest is charged not only on the principal amount borrowed, but also on any accumulated interest. This increases the amount owed over time, effectively raising the cost of short-term credit.

Question 11

A cash conversion cycle of -5 days is better than a cash conversion cycle of 50 days.

Accepted Answer

A negative cash conversion cycle means that a company is receiving cash from customers before it has to pay its suppliers, which is a good sign of efficient working capital management. On the other hand, a positive cash conversion cycle means a company is paying its suppliers before receiving payment from its customers, leading to cash flow problems. Therefore, a cash conversion cycle of -5 days is much better than a cycle of 50 days.

Question 12

In the context of managing working capital,the hedging principle refers to which of the following?

Accepted Answer

The hedging principle in the context of managing working capital involves matching the maturity of the source of financing to the cash flow generating characteristics of the asset being financed. This helps to minimize the risk of financing costs increasing due to changes in interest rates. While interest rate swaps can be used to manage interest rate risk, they are not necessarily tied to the hedging principle in working capital management. Speculation regarding the direction of short-term interest rates and protecting the firm against the risk of rising interest rates are not directly related to the concept of hedging in working capital management.

Question 13

One way to improve a company's cash conversion cycle is to increase its days sales outstanding.

Accepted Answer

Increasing days sales outstanding means that it takes longer for the company to collect payment from its customers, which would actually lengthen the cash conversion cycle. Therefore, decreasing days sales outstanding would be a better way to improve the cash conversion cycle.

Question 14

Which of the following is considered a spontaneous source of financing?

Accepted Answer

Accounts payable are considered a spontaneous source of financing because they arise from business operations and do not require any formal agreement or negotiation between parties. They represent amounts owed to suppliers for goods or services that have already been received and are typically due within a short period of time, such as 30 days. Short-term notes payable and long-term notes payable require formal agreements and negotiations with creditors, while preferred stock represents equity financing rather than debt financing.

Question 15

The cash conversion cycle cannot be negative.

Accepted Answer

The cash conversion cycle can indeed be negative if a company is able to sell its products and collect the cash from sales before it has to pay its suppliers for the inventory. This indicates a highly efficient operation where the company is effectively using its suppliers' resources to finance its sales.

Question 16

What is the hedging principle or principle of self-liquidating debt?

Accepted Answer

The answer of What is the hedging principle or principle...

Question 17

With regard to the hedging principle,which of the following assets should be financed with current liabilities?

Accepted Answer

The hedging principle suggests that current assets should be financed with current liabilities to minimize the risk of default. Accounts receivable are considered current assets, and financing the expansion of accounts receivable with current liabilities can help match the timing of cash inflows and outflows. Financing long-term assets such as machinery and buildings with short-term (current) liabilities can increase the risk of default, as these liabilities may need to be refinanced before the assets generate enough cash to repay them. The minimum level of cash required for year-round operations is typically financed with short-term debt, but this is not explicitly stated as an option in the question.

Question 18

With regard to the hedging principle,which of the following would be an appropriate method to finance a minimum level of current assets required for year round operations?

Accepted Answer

The hedging principle suggests matching the maturity of assets and liabilities to manage risk. Financing a minimum level of current assets required for year-round operations, which are long-term in nature, would be appropriately done with long-term financing such as issuing common stock.

Question 19

What three actions can a firm take to minimize its net working capital?

Accepted Answer

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Question 20

According to the hedging principle,which of the following assets should be financed with permanent sources of financing?

Accepted Answer

The hedging principle suggests that permanent sources of financing should be used to finance those assets that are maintained throughout the year, in order to avoid the risk of having to liquidate long-term assets to cover short-term liabilities. Inventory and accounts receivable are typically held by a firm throughout the year, and are therefore best financed with permanent sources of financing. Seasonal expansions of inventory and increases in accounts receivable, on the other hand, are temporary in nature and can be financed with short-term sources of financing, such as a line of credit or a short-term loan.

Quiz 15: Working-Capital Management