1.The appropriate mix of current assets is not a working capital management decision.

A) True
B) False
Ans: B
Chapter 14: Working Capital Management

2.Net working capital is important because it is a measure of a firm’s liquidity and represents the
net short-term investment the firm keeps in the business.
A) True
B) False
Ans: A

3.Working capital management involves making decisions regarding the use and sources of current
assets.
A) True
B) False
Ans: A

4.Working capital efficiency refers to the length of time it takes for a firm to convert the raw
material to a finished product.
A) True
B) False
Ans: B

5.Liquidity is the ability of a company to convert assets—real or financial—into cash quickly

without suffering a financial loss.
A) True
B) False
Ans: A

6.The operating cycle begins when the firm uses its cash to purchase raw materials and ends when
the firm collects cash payments on its credit sales.
A) True
B) False
Ans: B

7.The cash conversion cycle is the length of time between the cash outflow for materials and the
cash inflow from sales.
A) True
B) False
Ans: A

8.Days' payables outstanding (DPO), which tells how long, on average, a firm takes to pay off its
suppliers for the cost of inventory, is used to measure the operating cycle.
A) True
B) False
Ans: B
 9.
Day’s payables outstanding (DPO) is computed as number of days in a year divided by accounts
payable turnover.
A) True
B) False
Ans: A

10.An efficient firm with good working capital management should have a high average collection
period compared to that of its industry.
A) True
B) False
Ans: B

11.The flexible current asset management strategy calls for management to invest large amounts in
cash, short-term investments, and inventory.
A) True
B) False
Ans: A

12.The flexible current asset management strategy is perceived to be a high-risk and low-return
course of action for management to follow.
A) True
B) False
Ans: B

13.The restrictive current asset management strategy is a high-risk, high-return alternative to a

flexible strategy.
A) True
B) False
Ans: A

14.If shortage costs dominate carrying costs, the firm will need to move toward a more flexible
policy.
A) True
B) False
Ans: A

15.If carrying costs are less than shortage costs, then the firm will maximize value by adopting a
more restrictive strategy.
A) True
B) False
Ans: B

16.Trade credit, which is short-term financing, comes with an explicit interest charge.
A) True
B) False
Ans: B
 17.An offer of 3/10, net 40 means that the selling firm offers a 10 percent discount if the buyer pays
the full amount of the purchase in cash within 3 days of the invoice date. Otherwise, the buyer
has 40 days to pay the balance in full from the date of delivery.
A) True
B) False
Ans: B

18.Trade credit is a cheap loan from the supplier.

A) True
B) False
Ans: B

19.The aging schedule shows the breakdown of the firm's accounts receivable by their date of sale.

A) True
B) False
Ans: A

20.The conflict between carrying costs and shortage costs is called the working capital trade-off.
A) True
B) False
Ans: A

21.A firm that employs just-in-time management has to increase its investment in working capital.
A) True
B) False
Ans: B

22.Float is the time taken by a credit customer to pay the firm.

A) True
B) False
Ans: B

23.A lockbox system allows geographically dispersed customers to send their payments to a post
office box close to them.
A) True
B) False
Ans: A

24.Under the maturity matching strategy, a firm funds all seasonal working capital needs with short-
term borrowing.
A) True
B) False
Ans: A

25.Short term funding strategy calls for all seasonal working capital and a portion of the
permanent working capital and fixed assets to be funded with short-term debt.
A) True
B) False
Ans: A

26.An informal line of credit is short term debt promissory notes issued by large financial
firms.
A) True
B) False
Ans: B

27.A factor is an individual or financial institution that buys accounts receivable without
recourse.
A) True
B) False
Ans: A

28.Which of the following statements is NOT true?

A) Gross working capital is the funds invested in a company's current liabilities.
B) Net working capital (NWC) refers to the difference between current assets and current
liabilities.
C) Working capital efficiency refers to the length of time between when a working capital
asset is acquired and when it is converted into cash.
D) Working capital management involves making decisions regarding the use and sources of
current assets.
Ans: A

29.Which of the following statements is NOT true?

A) If cash balances become too small, it may lead the firm to bankruptcy.

B) The lower the cash balance, the better the ability of a firm to meet its short-term financial
obligations.
C) The level of the cash balance has no bearing on a firm's ability to meet its short-term
financial obligations.
D) The downside of holding too much cash is that the returns on cash are low.
Ans: B
30.Which of the following is the equation for net working capital?
A) Total assets – total liabilities
B) Current assets – current liabilities
C) Current assets / current liabilities
D) Total assets / total liabilities
Ans: B

31.The cash conversion cycle

A) Shows how long a firm keeps its inventory before selling it.
B) Begins when a firm invests cash to purchase the raw materials that would be used to
produce the goods that the firm manufactures.
C) begins when a firm uses its cash to purchase raw materials and ends when the firm
collects cash payments on its credit sales.
D) estimates how long it takes on average for a firm to collect its outstanding accounts
receivable balance.
Ans: B

32.Which of the following statements is NOT true?

A) The cash conversion cycle begins when a firm invests cash to purchase the raw
materials that would be used to produce the goods that the firm manufactures.
B) The cash conversion cycle begins when the firm uses its cash to purchase raw materials
and ends when the firm collects cash payments on its credit sales.
C) To measure the cash conversion cycle, we need another measure called the days'
payables outstanding.
D) The cash conversion cycle ends not with the finished goods being sold to customers and
the cash collected on the sales; but when you take into account the time taken by a firm
to pay for its purchases.
Ans: B

33.The operating cycle

A) Begins when a firm receives the raw materials that would be used to produce the goods
that the firm manufactures.
B) begins when a firm uses its cash to purchase raw materials and ends when the firm collects
cash payments on its credit sales.
C) cannot be measured without knowing the days' payables outstanding.
D) does not end with the finished goods being sold to customers and the cash collected on the
sales; but when you take into account the time taken by the firm to pay for its purchases.
Ans: A

34.Which of the following statements is true when managing working capital accounts?
A) Maintain minimal raw material inventories without causing manufacturing delays.
B) Use as little labor as possible to manufacture the product while producing a quality
product.
C) Delay paying accounts payable as long as possible without suffering any penalties.
D) All of the above are true.
Ans: D

35.Which of the following statements is true?

A) Cash conversion cycle  DSO  DSI  DPO
B) Cash conversion cycle  DSO  DSI  DPO
C) Cash conversion cycle  DSO  DPO
D) None of the above.
Ans: B

36.Which of the following statements is NOT true?

A) Cash conversion cycle  DSO  DSI  DPO
B) Operating cycle  DSO  DSI
C) Both A and B
D) None of the above
Ans: D
 37.Trend Foods distributes its products to more than 100 restaurants and delis. The
company's collection period is 32 days, and it keeps its inventory for 10 days. What is
Trend's operating cycle?
A) 22 days
B) 32 days
C) 42 days
D) None of the above
Ans: C
Feedback:
Operating cycle  DSO  DSI
 32  10
 42 days

38.Stamp, Inc. has an operating cycle of 81 days and takes 47 days to collect on its receivables.
What is its level of inventory if the firm's cost of goods sold is $312,455? Round your final
answer to the nearest dollar.
A) $9,190
B) $14,685
C) $29,105
D) $69,339
Ans: C
Feedback:
Operating cycle = DSO + DSI
DSI = OC – DSO = 81 – 47 = 34 days
Inventory Inventory Inventory
DSI  34 days   
COGS 365 $312,455 365 $856.04
Inventory  34  856.04  $29,105.40

39.Le Baron Company, a men's designer firm, has an operating cycle of 123 days. The firm's
days' sales in inventory is 73 days. How much does the firm have in receivables if it has
credit sales of $433,450? Round your final answer to the nearest dollar.
A) $59,377
B) $71,252
C) $47,501
D) $64,233
Ans: A
Feedback:
Operating cycle = DSO + DSI
DSO = OC – DSI = 123 – 73 = 50 days
Credit sales = $433,450
Accounts receivables Accounts receivables
DSO    50 days
Credit sales 365 $433, 450 365
Accounts receivables  50  $1,187.53  $59, 376.71

40.All Stars, Inc. has inventory of $44,233 and cost of goods sold of $512,902. The company
has an operating cycle of 74 days. What is the firm's days' sales outstanding (DSO)? Round
your answers to the nearest whole number.
A) 43 days
B) 32 days
C) 49 days
D) 26 days
Ans: A
Feedback:
Inventory $44,233
DSI    31.5 days
COGS 365 $512,902 365
Operating cycle = DSO + DSI
DSO = Operating cycle – DSI = 74 – 31.5 = 42.5 days OR 43 days

Reference: 14-1: Use the following information to answer questions 41-42:

You are provided the following working capital information for the Ridge Company:

Ridge Company
Account
Inventory $12,890
Accounts receivable 12,800
Accounts payable 12,670

Credit sales $124,589

Cost of goods sold 99,630

41.What is the operating cycle for Ridge Company? Round your final answer to the nearest
whole number.
A) 47 days
B) 85 days
C) 36 days
D) 51 days
Ans: B
Feedback:

42.What is the cash conversion cycle for Ridge Company? Round your final answers to one
decimal place.
A) 83.5 days
B) 38.3 days
C) 129.9 days
D) 46.4 days
Ans: B
Feedback:

43.Wolfgang Electricals estimates that the company takes 31 days on average to pay off its
suppliers. It also knows that it has days' sales in inventory of 54 days and days sales'
outstanding of 34 days. What is its cash conversion cycle?
A) 119 days
B) 34 days
C) 57 days
D) 46 days
Ans: C
Feedback:
Cash conversion cycle = DSO + DSI – DPO = 34 + 54 – 31 = 57 days

44.Renald Corp. estimates that the company takes 27 days on average to pay off its suppliers.
It also knows that it has days' sales in inventory of 43 days and days sales' outstanding of
45 days. What is its cash conversion cycle?
A) 61 days
B) 115 days
C) 57 days
D) 46 days
Ans: A

Cash conversion cycle = DSO + DSI – DPO = 45 + 43 – 27 = 61 days

45.Your boss asks you to compute the company's cash conversion cycle. Looking at the
financial statements, you see that the average inventory for the year was $126,300, accounts
receivable were $97,900, and accounts payable were at $115,100. You also see that the
 company had credit sales of $324,000 and that cost of goods sold was $282,000. What is
your firm's cash conversion cycle? Round to the nearest day.
A) 119 days
B) 34 days
C) 57 days
D) 125 days
Ans: D
Feedback:
Accounts receivables $97,900
DSO    110.3 days
Credit sales 365 $324, 000 365
Inventory $126,300
DSI    163.5 days
COGS 365 $282, 000 365
Accounts payables $115,100
DPO    149 days
COGS 365 $282, 000 365
Cash conversion cycle  DSO  DSI  DPO
 110.3  163.5  149
 124.8 days

46.West Handicrafts, Inc. has net sales of $423,000 with 30 percent of it being credit sales. Its
cost of goods sold is $324,000. The firm's cash conversion cycle is 47.9 days. The firm's
operating cycle is 86.3 days. What is the firm's accounts payable? Round to the nearest
dollar. Do not round your intermediate calculations.
A) $34,087
B) $126,900
C) $71,203
D) $56,322
Ans: A
Feedback:
Net sales = $423,000
Credit sales = (0.3 × $423,000) = $126,900
Cash conversion cycle  ( DSO  DSI )  DPO
47.9  86.3  DPO
DPO  38.4 days
Accounts payables Accounts payables
DPO    38.4 days
COGS 365 $324, 000 365

Accounts payables  38.4  $887.67  $34, 086.53

47.The flexible current asset investment strategy

A) has a high percent of current assets to sales, is generally perceived to be a low-risk and
low-return course of action.
B) calls for management to invest large amounts in cash, short-term investments, and
 inventory.
C) leads to high levels of accounts receivable.
D) All of the above
Ans: D

48.Which of the following is NOT true about the flexible current asset investment strategy?
A) The strategy promotes a liberal trade credit policy for customers.
B) The strategy calls for management to invest large amounts in cash, short-term
investments, and inventory.
C) The strategy is perceived be a high-risk and high-return course of action for management
to follow.
D) The strategy's downside is the high inventory carrying cost.
Ans: C
49.A restrictive current asset investment strategy calls for
A) levels of current assets kept to a minimum.
B) a firm barely investing in cash, marketable securities and inventory.
C) tight terms of sale intended to curb credit sales and accounts receivable.
D) All of the above
Ans: D

50.The restrictive current asset management strategy is a high-risk, high-return alternative to

the flexible strategy because of
A) financial shortage costs.
B) production shortage costs.
C) human resources shortage costs.
D) None of the above
Ans: A

51.Which of the following statements is true?

A) Financial shortage costs arise mainly from illiquidity—shortage of cash or a lack of
marketable securities to sell for cash.
B) Operating shortage costs result from lost production and sales.
C) Operating shortage costs can be substantial, especially if the product markets are
competitive.
D) All of the above.
Ans: D

52.Operating shortage costs that result from lost production and sales are caused by
A) not holding enough raw materials in inventory.
B) running out of finished goods.
C) restrictive credit policies.
D) All of the above.
Ans: D

53.Which of the following statements about working capital trade-off is true?

A) Financial managers need to balance shortage costs against carrying costs to find an
optimal management strategy.
B) If carrying costs are greater than shortage costs, then the firm will maximize value by
adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a more
 flexible policy.
D) All of the above
Ans: D

54.Which of the following statements about working capital trade-off is NOT true?
A) Financial managers need to balance shortage costs against carrying costs to find an
optimal management strategy.
B) If carrying costs are smaller than shortage costs, then the firm will maximize value by
adopting a more restrictive strategy.
C) If shortage costs dominate carrying costs, the firm will need to move toward a more
flexible policy.
D) Management will try to find the level of current assets that minimizes the sum of the
carrying costs and shortage costs.
Ans: B

55.The aging schedule

A) shows the breakdown of a firm's accounts receivable by their date of sale.
B) identifies and then tracks delinquent accounts to see that they are paid.
C) is an important financial tool for analyzing the quality of a company's receivables.
D) All of the above.
Ans: D

56.Which of the following statements is NOT true?

A) Accounts payable (trade credit), bank loans, and commercial paper are common sources of
short-term financing.
B) An informal line of credit is a verbal agreement between the firm and the bank, allowing
the firm to borrow up to an agreed-upon limit.
C) An informal line of credit is a special type of collateralized loan.
D) A formal line of credit is also known as “revolving credit.”
Ans: C

57.Senter Corp. sells its goods with terms of 2/10 EOM, net 30. What is the implicit cost of the
trade credit? Round your final percentage answer to 2 decimal places. Do not round your
intermediate calculations.
A) 18.50%
B) 30.00%
C) 44.59%
D) 21.89%
Ans: C
Feedback:
Credit terms = 2/10 EOM, net 30
Effective annual rate = (1 + (Discount / Discounted price)) 365 / days credit – 1
365 / 20
= (1 + 2 / 98) – 1 = (1.0204)18.2500 – 1 = 1.4459 – 1 = 0.4459, or 44.59%

58.Kearns, Inc. sells its goods with terms of 3/15 EOM, net 60. What is the implicit cost of the
trade credit? Round your final answer to the nearest whole percent. Do not round your
intermediate calculations.
A) 15%
B) 45%
C) 34%
D) 28%
Ans: D
Feedback:
Credit terms = 3/15 EOM, net 60
Effective annual rate= (1 + (Discount / Discounted price)) 365 / days credit – 1
= (1 + 3 / 97)365/45 – 1 = (1.0309)8.1111 – 1 = 1.2800 – 1 = 0.28, or 28%

59.Which of the following statements is true of economic order quantity (EOQ)?

A) The EOQ mathematically determines the minimum total inventory cost.
B) The EOQ takes into account inventory reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) All of the above
Ans: D

60.Which of the following statements is NOT true of economic order quantity (EOQ)?
A) The economic order quantity (EOQ) mathematically determines the minimum total
inventory cost.
B) The EOQ ignores inventory reorder costs and inventory carrying costs.
C) The optimal order size is determined by the EOQ model.
D) The EOQ is directly proportional to the sales per period.
Ans: B

61.Which of the following statements about just-in-time inventory management policy is

NOT true?
A) It calls for the exact day-by-day, or even hour-by-hour raw material needs to be delivered
by the suppliers.
B) If the supplier fails to make the needed deliveries, then production shuts down.
C) A big disadvantage in this system is that there are high raw inventory costs.
D) It eliminates obsolescence or loss to theft.
Ans: C

Reference 14-2: Use the following to answer questions 62-63:

Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an
order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in
late fall of each year.

62.What is the number of cars per order? Round your final answer to the nearest whole number.
A) 80 cars
B) 101cars
C) 58 cars
D) 113 cars
Ans: C
Feedback:
 2  Reorder costs  Sales per period
EOQ 
Carrying cos ts
2  $1,100  700
  113.3
$120
The number of cars per order = 113 cars.

63.How many orders will the dealer need to place this year? Round your answer to the whole
number.
A) 4 orders
B) 5 orders
C) 6 orders
D) 7 orders
Ans: C
Feedback:
Number of orders = 700 / 113 = 6 orders.

64.Ticktock Clocks sells 10,000 alarm clocks each year. If the total cost of placing an order is
$65 and it costs $85 per year to carry the alarm clock in inventory, calculate the optimal
order size using the EOQ formula. Round your final answer to nearest whole number.
A) 124 clocks
B) 161 clocks
C) 15,294 clocks
D) 26,154 clocks
Ans: A
Feedback:
2  Reorder costs  Sales per period
EOQ 
Carrying cos ts
2  $65  10,000
  123.7
$85
The optimal order size = 124 clocks.

65.Which of the following statements about collection time is NOT true?

A) Collection time, or float, is the time between when a customer makes a payment and when
the cash becomes available to the firm.
B) Collection time can be broken down into three components.
C) Delivery time or mailing time is not part of the collection time.
D) Processing delay is one of the components of the collection time.
Ans: C

66.Porter Corp. has just signed up for a lockbox. Management expects the lockbox to reduce
the mail float by 2.3 days. The firm's sales on average are $41,250 a day, with the average
check being $165. The bank charges $0.39 per processed check. Assume that there are 270
business days in a year and the opportunity cost of funds is 5 percent. What will the firm's
 savings be from using the lockbox?
A) $3,427.50
B) $975.50
C) $2,632.50
D) $94,875.00
Ans: A
Feedback:
Average daily sales = $41,250
No. of business days = 270
Average check amount = $165
No. of checks processed per day = $41,250 / $165 = 250
Collection time saved = 2.3 days
Per check processing fee = $0.39
Opportunity cost of funds = 0.05
The cost of a lockbox = 250 checks × $0.39 per check × 270 days = $26,325
Savings from mail float = 2.3 days × $41,250 = $94,875
Savings from lockbox = ($94,875 – $26,325) × 0.05 = $68,550 × 0.05 = $3,427.50

67.Rocky Corp. has daily sales of $18,100. The financial manager determined that a lockbox
would reduce the collection time by 2.2 days. Assuming the company can earn 6 percent
interest per year, what are the savings from the lockbox? Round your final answer to the
nearest dollar.
A) $3,621
B) $2,389
C) $39,820
D) $1,100
Ans: B
Feedback:
Average daily sales = $18,100
Collection time saved = 2.2 days
Savings from mail float = 2.2 days × $18,100 = $39,820
Savings from the lockbox = $39,820 × 0.06 = $2,389

68.Which of the following statements about maturity matching strategy is true?

A) All seasonal working capital needs are funded with short-term borrowing.
B) As the level of sales varies seasonally, short-term borrowing fluctuates with the level of
seasonal working capital.
C) All fixed assets are funded with long-term financing.
D) All of the above
Ans: D

69.Which of the following statements about short-term funding strategy is true?

A) All seasonal working capital needs and a portion of permanent working capital and fixed
assets are funded with short-term debt.
B) The downside to this strategy is that a portion of a firm’s long-term assets must be
periodically refinanced over their working lives.
C) It can take advantage of an upward-sloping yield curve and lower a firm’s overall cost of
funding.
D) All of the above
 Ans: D

70.Which of the following statements is NOT true?

A) Firms using maturity matching strategy fund all working capital needs with long-term
borrowing.
B) Long-term financing strategy relies on long-term debt to finance both capital assets and
working capital.
C) All permanent working capital and fixed assets are funded with long-term debt when firms
use a maturity matching strategy.
D) Firms using a maturity matching strategy fund all seasonal working capital needs with
short-term borrowing.
Ans: A

71.Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 percent. The loan calls for a
compensating balance of 8 percent. What is the effective interest rate for this company?
Round your final percentage answer to two decimal places.
A) 9.24%
B) 8.50%
C) 8.00%
D) 16.50%
Ans: A
Feedback:
Amount to be borrowed = $50,000
Stated annual interest rate = 8.5%
Compensating balance = 8%
Amount deposited as compensating balance = $50,000 × 0.08 = $4,000
Effective borrowing amount = $50,000 – $4,000 = $46,000
Interest expense = $50,000 × 0.085 = $4,250
Effective interest rate = Interest expense / Effective borrowing amount = $4,250 / $46,000 =
9.24%

72.Sun Prairie Traders borrowed $63,000 at an APR of 10 percent. The loan called for a
compensating balance of 10 percent. What is the effective interest rate on the loan? Round
your final percentage answer to two decimal places.
A) 10.00%
B) 11.11%
C) 8.00%
D) 12.50%
Ans: B
Feedback:
Amount to be borrowed = $63,000
Stated annual interest rate = 10%
Compensating balance = 10%
Amount deposited as compensating balance = $63,000 × 0.10 = $6,300
Effective borrowing amount = $63,000 – $6,300 = $56,700
Interest expense = $63,000 × 0.10 = $6,300
Effective interest rate = $6,300 ÷ $56,700 = 11.11%
 73.Good Homes Furnishings is borrowing $225,000. The loan requires a 10 percent
compensating balance, and the effective interest rate on loan is 8.25 percent. What is the
stated APR on this loan? Round your final percentage answer to two decimal places. Do not
round your intermediate calculations.
A) 10.00%
B) 11.11%
C) 7.43%
D) 8.25%
Ans: C
Feedback:
Amount to be borrowed = $225,000
Effective interest rate = 8.25%
Compensating balance = (0.10 × $225,000) = $22,500
Effective borrowed amount = $225,000 – $22,500 = $202,500
Interest expense = Effective interest rate × Effective borrowing amount = 0.0825 × $205,500 =
$16706.25.
Stated interest rate = $16,706.25 / $225,000 = 7.43%

74.Maggie's Bistro is borrowing $375,000. The loan requires an 8 percent compensating

balance, and the effective interest rate on the loan is 10.326 percent. What is the stated APR
on this loan? Round your final percentage answer to 1 decimal place. Do not round your
intermediate calculations.
A) 10.0%
B) 9.5%
C) 7.4%
D) 8.5%
Ans: B
Feedback:
Amount to be borrowed = $375,000
Compensating balance = (0.08 × $375,000) = $30,000
Effective interest rate = 10.326%
Effective borrowed amount = $375,000 – $30,000 = $345,000
Interest expense = Effective interest rate × Effective borrowing amount = 0.10326 × $345,000 =
$35,625.
Stated interest rate = $35,625 / $375,000 = 9.5%

75.Gibbs, Inc. has just set up a formal line of credit of $1 million with First National Bank.
The line of credit is good for up to five years. The bank will be charging them an interest
rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 50 basis
points on the unused balance. The firm borrowed $600,000 on the first day the credit line
became available. What is the firm's effective interest rate on this line of credit? Round
your final percentage answer to 2 decimal places.
A) 8.00%
B) 7.25%
C) 6.58%
D) 8.25%
Ans: C
Feedback:
 Line of credit limit = $1,000,000
Loan rate = 6.25%
Annual fee on unused balance = 0.5%
Amount borrowed = $600,000
Unused balance = $400,000
Annual fee = $400,000 × 0.005 = $2,000
Interest expense = $600,000 × 0.0625 = $37,500
Effective interest rate = (Interest expense + Annual fee) / Borrowed amount = ($37,500 +
$2,000) / $600,000 = 6.58%

76.Trend, Inc. has just set up a formal line of credit of $5 million with First National Bank.
The line of credit is good for up to three years. The bank will be charging them an interest
rate of 7.5 percent on the loan, and in addition, the firm will pay an annual fee of 50 basis
points on the unused balance. The firm borrowed $2,300,000 on the first day the credit line
became available. What is the firm's effective interest rate on this line of credit? Round
your final percentage answer to one decimal place.
A) 8.5%
B) 7.2%
C) 9.0%
D) 8.1%
Ans: D
Feedback:
Line of credit limit = $5,000,000
Loan rate = 7.5%
Annual fee on unused balance = 0.5%
Amount borrowed = $2,300,000
Unused balance = $2,700,000
Annual fee = $2,700,000 × 0.005 = $13,500
Interest expense = $2,300,000 × 0.075 = $172,500
Effective interest rate = (Interest expense + Annual fee) / Borrowed amount = ($172,500 +
$13,500) / $2,300,000 = 8.09% OR 8.1%

77. Storm Electronics has set up a formal line of credit of $2 million with First Kentucky
Bank. The line of credit is good for up to three years. The bank will be charging them an
interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee
of 60 basis points on the unused balance. The firm borrowed $1,500,000 on the first day
the credit line became available. What is the firm's effective interest rate on this line of
credit? Round your final percentage answer to two decimal places.
A) 7.50%
B) 6.45%
C) 6.25%
D) 7.15%
Ans: B
Feedback:
Line of credit limit = $2,000,000
Loan rate = 6.25%
Annual fee on unused balance = 0.6%
Amount borrowed = $1,500,000
 Unused balance = $500,000
Annual fee = $500,000 × 0.006 = $3,000
Interest expense = $1,500,000 × 0.0625 = $93,750
Effective interest rate = (Interest expense + Annual fee) / Borrowed amount =
($93,750 + $3,000) / $1,500,000 = 6.45%.

78. Pride, Inc. sells $150,000 of its accounts receivable to factors at 2.875 percent discount. The
firm's average collection period is 75 days. What is the simple annual interest cost of the
factors loan? Round your percentage answer to one decimal place.
A) 35.5%
B) 32.9%
C) 27.8%
D) 31.1%
Ans: A
Feedback:
Accounts receivables sold = $150,000
Factor discount = 2.875%
Simple monthly interest cost of factoring = 2.875 / (100 –2.875) = 2.875 / 97.125 = 0.0296
Simple annual interest cost of factors loan = 0.0296 × 12 = 35.5%.
79.A firm sells $125,000 of its accounts receivable to factors at 3 percent discount. The firm's
average collection period is one month. What is the dollar cost of the factoring service?
A) $3,000
B) $4,500
C) $3,750
D) $4,250
Ans: C
Feedback:
Accounts receivables sold = $125,000
Factor discount = 3%
Average collection period = 30 days
Dollar cost of factoring per month = $125,000 × 0.03 = $3,750

80.Which of the following is a short-term financing instrument?

A) Accounts payable
B) Bank loans with a maturity of less than 1 year
C) Commercial paper
D) All of the above
Ans: D

81.What are some strategies that financial managers can follow in managing their working
capital accounts?
 When managing working capital accounts, financial managers need to do the following:
Delay paying accounts payable as long as possible without suffering any penalties.
Maintain minimal raw material inventories without causing manufacturing delays.
Use as little labor as possible to manufacture the product while producing a
quality product.
Maintain minimal finished goods inventories without losing sales.
Offer customers the most attractive credit terms possible on trade credit to
maximize sales while minimizing the risk of nonpayment.
Collect cash payments on accounts receivable as fast as possible to close the loop.

82.Explain working capital trade-off.

Ans: The optimal current asset management strategy of a firm will depend on the relative
magnitudes of carrying costs versus shortage costs. This conflict is often referred to as the
working capital trade-off.
Financial managers need to balance shortage costs against carrying costs to find out an
optimal strategy. If carrying costs are larger than shortage costs, then the firm will
maximize value by adopting a more restrictive strategy.
On the other hand, if shortage costs dominate carrying costs, the firm will need to move
toward a more flexible policy. Overall, management will try to find the level of current
assets that minimizes the sum of the carrying costs and shortage costs.

83.How does a just-in-time inventory management work?

Ans: In a just-in-time system, the exact day-by-day or even hour-by-hour raw material
needs are delivered by the suppliers, who deliver the goods “just in time” for them to
be used on the production line. A big advantage in this system is that there are
essentially no raw material inventory costs and no chance of obsolescence or loss to
theft. On the other hand, if the supplier fails to make the needed deliveries, then
production shuts down. If the system works for a firm, it cuts down their investment in
working capital dramatically.