7: (131) Working Capital Management

1: (17) Working Capital

2: (33) Cash Management
3: (10) Marketable Securities Management
4: (40) Receivables Management
5: (31) Inventory Management

1: (17) Working Capital

Question: 1 A board of directors has determined 4 options to increase working capital next year.
Option 1 is to increase current assets by $120 and decrease current liabilities by $50.
Option 2 is to increase current assets by $180 and increase current liabilities by $30.
Option 3 is to decrease current assets by $140 and increase current liabilities by $20.
Option 4 is to decrease current assets by $100 and decrease current liabilities by $75.
Which option should the board of directors choose to maximize net working capital?

A. Option 4.

B. Option 3.

C. Option 1.

D. Option 2.

Question: 2 If a firm increases its cash balance by issuing additional shares of common stock, net
working capital

A. Increases and the current ratio decreases.

B. Increases and the current ratio remains unchanged.

C. Increases and the current ratio increases.

D. Remains unchanged and the current ratio remains unchanged.

Question: 3 Determining the appropriate level of working capital for a firm requires

A. Maintaining a high proportion of liquid assets to total assets in order to maximize the
return on total investments.

B. Changing the capital structure and dividend policy of the firm.

C. Maintaining short-term debt at the lowest possible level because it is generally more
expensive than long-term debt.

D. Offsetting the benefit of current assets and current liabilities against the probability
of technical insolvency.

Question: 4 As a company becomes more conservative in its working capital policy, it would tend to
have a(n)

A. Increase in the ratio of current assets to units of output.

B. Increase in funds invested in common stock and a decrease in funds invested in

marketable securities.

C. Decrease in its acid test ratio.

D. Increase in the ratio of current liabilities to noncurrent liabilities.

Question: 5 All of the following statements in regard to working capital are true except

A. The hedging approach to financing involves matching maturities of debt with

specific financing needs.

B. Financing permanent inventory buildup with long-term debt is an example of an

aggressive working capital policy.

C. Current liabilities are an important source of financing for many small firms.

D. Profitability varies inversely with liquidity.

Question: 6 Which one of the following combined transactions would cause net working capital to
decrease?
 A. A $1 million decrease in cash, and a $1 million increase in fixed assets.

B. A $1 million increase in cash, and a $1 million increase in long-term debt.

C. A $1 million decrease in cash, and a $1 million increase in inventory.

D. A $1 million decrease in cash, and a $1 million decrease in accounts payable.

Question: 7 Of the following, the working capital financing policy that would subject a firm to the
greatest level of risk is the one where the firm finances

A. Fluctuating current assets with long-term debt.

B. Permanent current assets with short-term debt.

C. Fluctuating current assets with short-term debt.

D. Permanent current assets with long-term debt.

Question: 8 A corporation is considering a plant expansion that will increase its sales and net
income. The following data represent management’s estimate of the impact the
proposal will have on the company:

Current Proposed

Cash $ 120,000 $ 140,000

Accounts payable 360,000 450,000

Accounts receivable 400,000 550,000

Inventory 360,000 420,000

Marketable securities 180,000 180,000

Mortgage payable (current) 160,000 310,000

Fixed assets 2,300,000 3,200,000

Net income 400,000 550,000

The effect of the plant expansion on net working capital will be a(n)

A. Increase of $230,000.
 B. Decrease of $10,000.

C. Increase of $10,000.

D. Increase of $240,000.

Question: 9 A company is experiencing a sharp increase in sales activity and a steady increase in
production, so management has adopted an aggressive working capital policy.
Therefore, the company’s current level of net working capital

A. Would most likely be higher than under other business conditions as the company’s
profits are increasing.

B. Would most likely be the same as in any other type of business condition as business
cycles tend to balance out over time.

C. Would most likely be higher than under other business conditions so that there will
be sufficient funds to replenish assets.

D. Would most likely be lower than under other business conditions in order that the
company can maximize profits while minimizing working capital investment.

Question: 10 Net working capital is the difference between

A. Current assets and current liabilities.

B. Shareholders’ investment and cash.

C. Fixed assets and fixed liabilities.

D. Total assets and total liabilities.

Question: 11 A company has current assets of $400,000 and current liabilities of $300,000. The
company could increase its net working capital by the

A. Purchase of $50,000 of trading securities for cash.

B. Prepayment of $50,000 of next year’s rent.

 C. Refinancing of $50,000 of short-term debt with long-term debt.

D. Acquisition of land valued at $50,000 through the issuance of common stock.

Question: 12 The working capital financing policy that subjects the firm to the greatest risk of being
unable to meet the firm’s maturing obligations is the policy that finances

A. Fluctuating current assets with long-term debt.

B. Permanent current assets with long-term debt.

C. Fluctuating current assets with short-term debt.

D. Permanent current assets with short-term debt.

Question: 13 C Corporation follows an aggressive financing policy in its working capital management
while L Corporation follows a conservative financing policy. Which one of the following
statements is correct?

A. C has a low ratio of short-term debt to total debt while L has a high ratio of short-
term debt to total debt.

B. C has less liquidity risk while L has more liquidity risk.

C. C has a low current ratio while L has a high current ratio.

D. C’s interest charges are lower than L’s interest charges.

Question: 14 During the year, current assets increased by $120,000, current liabilities decreased by
$50,000, and net working capital

A. Increased by $70,000.

B. Did not change.

C. Increased by $170,000.

D. Decreased by $170,000.
Question: 15 Shown below are selected data from a company’s most recent financial statements.

Marketable securities $10,000

Accounts receivable 60,000

Inventory 25,000

Supplies 5,000

Accounts payable 40,000

Short-term debt payable 10,000

Accruals 5,000
What is net working capital?

A. $80,000

B. $45,000

C. $35,000

D. $50,000

Question: 16 Which one of the following would increase the net working capital of a firm?

A. Refinancing a short-term note payable with a 2-year note payable.

B. Cash collection of accounts receivable.

C. Cash payment of payroll taxes payable.

D. Purchase of a new plant financed by a 20-year mortgage.

Question: 17 As a company becomes more conservative about its working capital management
policy, it would most likely tend to have a(n)

A. Increase in the ratio of current liabilities to noncurrent liabilities.

B. Decrease in the operating cycle.

C. Decrease in the quick ratio.

D. Increase in the ratio of current assets to noncurrent assets.

2: (33) Cash Management

Question: 1 According to John Maynard Keynes, the three major motives for holding cash are for

A. Speculative, social, and precautionary purposes.

B. Speculative, fiduciary, and transactional purposes.

C. Transactional, psychological, and social purposes.

D. Transactional, precautionary, and speculative purposes.

Question: 2 A company holding cash for a speculative motive is holding cash to

A. Provide a safety margin.

B. Pay bills.

C. Take advantage of future investment opportunities.

D. Protect against uncollectible receivables.

Question: 3 An entertainment ticketing service is considering the following means of speeding cash
flow for the corporation:

• Lock Box System. This would cost $25 per month for each of its 170 banks
and would result in interest savings of $5,240 per month.
• Drafts. Drafts would be used to pay for ticket refunds based on 4,000 refunds
per month at a cost of $2.00 per draft, which would result in interest savings of
$6,500 per month.
• Bank Float. Bank float would be used for the $1,000,000 in checks written
each month. The bank would charge a 2% fee for this service, but the
corporation will earn $22,000 in interest on the float.
• Electronic Transfer. Items over $25,000 would be electronically transferred; it
is estimated that 700 items of this type would be made each month at a cost of
$18 each, which would result in increased interest earnings of $14,000 per
month.

Which of these methods of speeding cash flow should be adopted?

 A. Lock box and electronic transfer only.

B. Lock box, drafts, and electronic transfer only.

C. Lock box, bank float, and electronic transfer only.

D. Bank float and electronic transfer only.

Question: 4 A firm has daily cash receipts of $200,000. A commercial bank has offered to reduce
the collection time by 3 days. The bank requires a monthly fee of $4,000 for providing
this service. If money market rates will average 12% during the year, the additional
annual income (loss) of having the service is

A. $24,000

B. $(24,000)

C. $68,000

D. $66,240

Question: 5 A compensating balance

A. Compensates a financial institution for services rendered by providing it with

deposits of funds.

B. Is a level of inventory held to compensate for variations in usage rate and lead time.

C. Is used to compensate for possible losses on a marketable securities portfolio.

D. Is the amount of prepaid interest on a loan.

Question: 6 What is the benefit for a firm with daily cash receipts of $15,000 to be able to speed up
collections by 2 days, assuming an 8% annual return on short-term investments and no
cost to the company to speed up collections?

A. $15,000 annual benefit.

B. $2,400 daily benefit.

 C. $2,400 annual benefit.

D. $30,000 annual benefit.

Question: 7 A typical firm doing business nationally cannot expect to accelerate its cash inflow by

A. Establishing multiple collection centers throughout the country.

B. Maintaining compensating balances rather than paying cash for bank services.

C. Initiating controls to accelerate the deposit and collection of large checks.

D. Employing a lockbox arrangement.

Question: 8 A company has daily cash receipts of $150,000. The treasurer of the company has
investigated a lockbox service whereby the bank that offers this service will reduce the
company’s collection time by four days at a monthly fee of $2,500. If money market
rates average 4% during the year, the additional annual income (loss) from using the
lockbox service would be

A. $6,000

B. $(12,000)

C. $12,000

D. $(6,000)

Question: 9 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.

A. $40,000

B. $200,000

C. $25,000

D. $175,000
Question: 10 A retail mail order firm currently uses a central collection system that requires all
checks to be sent to its headquarters. An average of 6 days is required for mailed
checks to be received, 3 days to process them, and 2 days for the checks to clear
through its bank. A proposed lockbox system would reduce the mailing and processing
time to 2 days and the check clearing time to 1 day. The firm has an average daily
collection of $150,000. If the firm adopts the lockbox system, its average cash balance
will increase by

A. $1,200,000

B. $600,000

C. $750,000

D. $450,000

Question: 12 A firm uses the following model to determine the optimal average cash balance (Q):

An increase in which one of the following would result in a decrease in the optimal cash balance?

A. Cash requirements for the year.

B. Uncertainty of cash outflows.

C. Return on marketable securities.

D. Cost of a security trade.

Question: 13 Purchases Sales

January $150,000 $100,000

February 150,000 200,000
March 150,000 250,000
April 130,000 250,000
May 130,000 300,000
June 100,000 230,000
A cash payment equal to 50% of purchases is made at the time of purchase, and 25%
is paid in each of the next 2 months. Purchases for the previous November and
December were $140,000 per month. Payroll for a month is 10% of that month’s sales,
and other operating expenses are 15% of the following month’s sales (July sales were
$210,000). Interest payments were $25,000 paid quarterly in January and April. Cash
disbursements for the month of April were

A. $130,000

B. $140,000

C. $235,000

D. $210,000

Question: 14 A firm has daily cash receipts of $300,000. A commercial bank has offered to reduce
the collection time by 2 days. The bank requires a monthly fee of $3,000 for providing
this service. If the money market rates will average 11% during the year, the annual
pretax income (loss) from using the service is

A. $(30,000)

B. $66,000

C. $63,000

D. $30,000

Question: 15A firm has daily cash receipts of $300,000. A bank has offered to provide a lockbox service that will
reduce the collection time by 3 days. The bank requires a monthly fee of $2,000 for providing this service. If money
market rates are expected to average 6% during the year, the additional annual income (loss) of using the lockbox
service is

A. $(24,000)
 B. $12,000

C. $54,000

D. $30,000

Question: 16 A major bank has agreed to provide a lockbox system to a company at a fixed fee of
$50,000 per year and a variable fee of $0.50 for each payment processed by the bank.
On average, the company receives 50 payments per day, each averaging $20,000.
With the lockbox system, the company’s collection float will decrease by 2 days. The
annual interest rate on money market securities is 6%. If the company makes use of
the lockbox system, what would be the net benefit to the company? Use 365 days per
year.

A. $60,875

B. $120,000

C. $59,125

D. $50,000

Question: 17Assume that each day a company writes and receives checks totaling $10,000. If it takes 5 days for
the checks to clear and be deducted from the company’s account, and only 4 days for the deposits to clear, what is
the float?

A. $10,000

B. $0

C. $50,000

D. $(10,000)

Question: 18A firm has daily cash receipts of $300,000 and is interested in acquiring a lockbox service in order to
reduce collection time. Bank 1’s lockbox service costs $3,000 per month and will reduce collection time by 3 days.
Bank 2’s lockbox service costs $5,000 per month and will reduce collection time by 4 days. Bank 3’s lockbox
service costs $500 per month and will reduce collection time by 1 day. Bank 4’s lockbox service costs $1,000 per
month and will reduce collection time by 2 days. If money market rates are expected to average 6% during the year,
and the firm wishes to maximize income, which bank should the firm choose?
 A. Bank 1.

B. Bank 2.

C. Bank 3.

D. Bank 4.

Question: 19 A consultant recommends that a company hold funds for the following two reasons:

1. Reason #1: Cash needs can fluctuate substantially throughout the year.
2. Reason #2: Opportunities for buying at a discount may appear during the year.
The cash balances used to address the reasons given above are correctly classified as
Reason #1 Reason #2

A. Speculative balances Precautionary balances

B. Speculative balances Speculative balances

C. Precautionary balances Precautionary balances

D. Precautionary balances Speculative balances

Question: 20 A company has extra cash at the end of the year and is analyzing the best way to
invest the funds. The company should invest in a project only if the

A. Expected return on the project is equal to the return on investments of comparable

risk.

B. Return on investments of comparable risk exceeds the expected return on the project.

C. Return on investments of comparable risk equals the expected return on the project.

D. Expected return on the project exceeds the return on investments of comparable risk.

Question: 21 A firm is considering a new accounts payable and cash disbursement process, which is
projected to add 3 days to the disbursement schedule without having significant
negative effects on supplier relations. Daily cash outflows average $1,500,000. The
 firm is in a short-term borrowing position for 8 months of the year and in an investment
position for 4 months. On an annual basis, bank lending rates are expected to average
7% and marketable securities yields are expected to average 4%. What is the
maximum annual expense that the firm could incur for this new process and still break
even?

A. $270,000

B. $315,000

C. $90,000

D. $180,000

Question: 22 All of the following are reasons for holding cash except for the

A. Transactions motive.

B. Motive to make a profit.

C. Precautionary motive.

D. Motive to meet future needs.

Question: 23 An entity has received proposals from several banks to establish a lockbox system to
speed up receipts. The entity receives an average of 700 checks per day averaging
$1,800 each, and its cost of short-term funds is 7% per year. Assuming that all
proposals will produce equivalent processing results and using a 360-day year, which
one of the following proposals is optimal for the entity?

A. A $0.50 fee per check.

B. A compensating balance of $1,750,000.

C. A flat fee of $125,000 per year.

D. A fee of 0.03% of the amount collected.

Question: 24 A retail mail order firm is currently using a central collection system that requires all
checks to be sent to its headquarters. An average of 5 days is required for mailed
 checks to be received, 4 days for the firm to process them, and 1 1/2 days for the
checks to clear through the bank. A proposed lockbox system would reduce the mail
and process time to 3 days and the check clearing time to 1 day. The firm has an
average daily collection of $100,000. If the firm should adopt the lockbox system, its
average cash balance would increase by

A. $250,000

B. $800,000

C. $400,000

D. $650,000

Question: 25 Shown below is a forecast of sales for the first 4 months of the year (all amounts are in
thousands of dollars).

January February March April

Cash sales $ 15 $ 24 $18 $14

Sales on credit 100 120 90 70

On average, 50% of credit sales are paid for in the month of sale, 30% in the month
following the sale, and the remainder is paid 2 months after the month of sale.
Assuming there are no bad debts, the expected cash inflow for March is

A. $108,000

B. $138,000

C. $122,000

D. $119,000

Question: 26 All of the following are valid reasons for a business to hold cash and marketable
securities except to

A. Earn maximum returns on investment assets.

B. Satisfy compensating balance requirements.

C. Maintain adequate cash needed for transactions.

 D. Meet future needs.

Question: 27 Average daily cash outflows are $3 million. A new cash management system can add 2
days to the disbursement schedule. Assuming that 10% can be earned on excess
funds, how much should the firm be willing to pay per year for this cash management
system?

A. $3,000,000

B. $6,000,000

C. $600,000

D. $1,500,000

Question: 28 The cash manager for a large kitchen appliance retailer has been approached by a
bank representative offering to set up a lockbox collection system. Analysis of the
firm’s receipts shows that, on average, the system will reduce collection time by 2
days. The firm receives approximately 2,500 checks per day with an average value of
$600 per check. The bank would charge $0.28 per check for operating the system. The
firm currently invests short-term funds at an average rate of 7%. How much would the
firm gain or lose annually by entering the lockbox agreement?

A. $(150,500)

B. $(45,500)

C. $210,000

D. $45,500

Question: 29 The owner of a newly established janitorial firm is deciding what type of checking
account to open. The firm is planning to keep a $500 minimum balance in the account
for emergencies and plans to write roughly 80 checks per month. The bank charges
$10 per month plus a $0.10 per check charge for a standard business checking
account with no minimum balance. The firm also has the option of a premium business
checking account that requires a $2,500 minimum balance but has no monthly fees or
per check charges. If the firm’s cost of funds is 10%, which account should the firm
choose?
 A. Standard account, because the savings is $16 per year.

B. Standard account, because the savings is $34 per year.

C. Premium account, because the savings is $16 per year.

D. Premium account, because the savings is $34 per year.

Question: 30 All of the following can be utilized by a firm in managing its cash outflows except

A. Zero-balance accounts.

B. Centralization of payables.

C. Lockbox system.

D. Controlled disbursement accounts.

Question: 31 An entity is considering implementing a lockbox collection system at a cost of $80,000

per year. Annual sales are $90 million, and the lockbox system will reduce collection
time by 3 days. If the entity can invest funds at 8%, should it use the lockbox system?
Assume a 360-day year.

A. Yes, producing savings of $60,000 per year.

B. No, producing a loss of $20,000 per year.

C. No, producing a loss of $60,000 per year.

D. Yes, producing savings of $140,000 per year.

Question: 32A lockbox system

 A. Provides security for late night deposits.

B. Accelerates the inflow of funds.

C. Reduces the need for compensating balances.

D. Reduces the risk of having checks lost in the mail.

Question: 33 Methods of accelerating cash collections include all of the following except

A. Electronic funds transfers.

B. Decentralized collections.

C. Compensating balances.

D. Lockbox systems.
3: (10) Marketable Securities Management

Question: 1 All of the following are alternative marketable securities suitable for investment except

A. Convertible bonds.

B. Eurodollars.

C. Commercial paper.

D. U.S. Treasury bills.

Question: 2 A firm is interested in purchasing a $100 U.S. Treasury bill and was presented with the
following options:

Annual Discount Rate

Due Date Yearly Rates

Option 1 180 days 6%

Option 2 360 days 3.5%

Option 3 120 days 8%

Option 4 240 days 4.5%

If the firm wishes to buy the Treasury bill at the lowest purchasing price, which option
should be chosen, assuming a 360-day year?

A. Option 2.

B. Option 3.

C. Option 4.

D. Option 1.

Question: 3 Which one of the following statements best characterizes U.S. Treasury bills?

A. They have no coupon rate, no interest rate risk, and are issued at par.
 B. They have no coupon rate, no default risk, and interest received is subject to federal
income tax.

C. They have an active secondary market, 1- to 24-month maturities, and monthly

interest payments.

D. They have an active secondary market, the interest received is exempt from federal
income tax, and there is no interest rate risk.

Question: 4 Which one of the following instruments would be least appropriate for a corporate treasurer to
utilize for temporary investment of cash?

A. Money market mutual funds.

B. Municipal bonds.

C. U.S. Treasury bills.

D. Commercial paper.

Question: 5 The best example of a marketable security with minimal risk would be

A. The commercial paper of an AAA-rated company.

B. Gold.

C. Municipal bonds.

D. The common stock of an AAA-rated company.

Question: 6 Which security is most often held as a substitute for cash?

A. Common stock.

B. Gold.
 C. Treasury bills.

D. Aaa corporate bonds.

Question: 7 When managing cash and short-term investments, a corporate treasurer is primarily
concerned with

A. Investing in Treasury bonds since they have no default risk.

B. Maximizing rate of return.

C. Minimizing taxes.

D. Liquidity and safety.

Question: 8 Short-term securities issued by the Federal Housing Administration are known as

A. Commercial paper.

B. Agency securities.

C. Bankers’ acceptances.

D. Repurchase agreements.

Question: 9 Assuming a 360-day year, the current price of a $100 U.S. Treasury bill due in 180
days on a 6% discount basis is

A. $100.00

B. $93.00

C. $97.00

D. $94.00
Question: 10 In smaller businesses in which the management of cash is but one of numerous
functions performed by the treasurer, various cost incentives and diversification
arguments suggest that surplus cash should be invested in

A. Commercial paper.

B. Money market mutual funds.

C. Bankers’ acceptances.

D. Corporate bonds.
4: (40) Receivables Management

Question: 1 Which one of the following statements is most likely to be true if a seller extends credit
to a purchaser for a period of time longer than the purchaser’s operating cycle? The
seller

A. Is, in effect, financing more than just the purchaser’s inventory needs.

B. Can be certain that the purchaser will be able to convert the inventory into cash
before payment is due.

C. Will have a lower level of accounts receivable than those companies whose credit
period is shorter than the purchaser’s operating cycle.

D. Has no need for a stated discount rate or credit period.

Question: 2The one item listed below that would warrant the least amount of consideration in credit and
collection policy decisions is the

A. Quantity discount given.

B. Level of collection expenditures.

C. Cash discount given.

D. Quality of accounts accepted.

Question: 3 Clauson, Inc., grants credit terms of 1/15, net 30 and projects gross credit sales for the
year of $2,000,000. The credit manager estimates that 40% of customers pay on the
15th day, 40% on the 30th day, and 20% on the 45th day. Assuming uniform sales and
a 360-day year, what is the projected amount of overdue receivables?

A. $400,000

B. $16,667

C. $50,000

D. $150,000
Question: 4 An established firm sells computer hardware, software, and services. The firm is
considering a change in its credit policy. It has been determined that such a change
would not change the payment patterns of the current customers. To determine
whether such a change would be beneficial, the firm has identified the proposed new
credit terms, the expected additional sales, the expected contribution margin on the
sales, the expected bad debt losses, and the investment in additional receivables and
the period of the investment. What additional information, if any, does the firm require
to determine the profitability of the proposed new policy as compared to the current
credit policy?

A. The credit standards that presently exist.

B. The new credit standards.

C. The opportunity cost of funds.

D. No additional information is needed.

Question: 5 A firm averages $4,000 in sales per day and is paid, on an average, within 30 days of
the sale. After they receive their invoice, 55% of the customers pay by check, while the
remaining 45% pay by credit card. Approximately how much would the company show
in accounts receivable on its balance sheet on any given date?

A. $48,000

B. $4,000

C. $120,000

D. $54,000

Question: 6 Hest Computers believes that its collection costs could be reduced through
modification of collection procedures. This action is expected to result in a lengthening
of the average collection period from 30 to 35 days; however, there will be no change
in uncollectible accounts, or in total credit sales. Furthermore, the variable cost ratio is
60%, the opportunity cost of a longer collection period is assumed to be negligible, the
company’s budgeted credit sales for the coming year are $45,000,000, and the
required rate of return is 6%. To justify changes in collection procedures, the minimum
annual reduction of costs (using a 360-day year and ignoring taxes) must be

A. $125,000

B. $22,500
 C. $375,000

D. $37,500

Question: 7 When a company analyzes credit applicants and increases the quality of the accounts
rejected, the company is attempting to

A. Maximize profits.

B. Increase bad-debt losses.

C. Increase the average collection period.

D. Maximize sales.

Question: 8 The average collection period for a firm measures the number of days

A. Beyond the end of the credit period before a typical customer payment is received.

B. For a typical check to “clear” through the banking system.

C. After a typical credit sale is made until the firm receives the payment.

D. Before a typical account becomes delinquent.

Question: 9 A company can increase annual sales by $150,000 if it sells to a new, riskier group of
customers. The uncollectible accounts expense is expected to be 16% of sales, and
collection costs will be 4%. The company’s manufacturing and selling expenses are
75% of sales, and its effective tax rate is 38%. If the company accepts this opportunity,
its after-tax income will increase by

A. $7,500

B. $2,850

C. $8,370

D. $4,650
Question: 10 A firm is changing its credit terms from net 30 to 2/10, net 30. The least likely effect of
this change would be a(n)

A. Increase in sales.

B. Lower number of days’ sales outstanding.

C. Increase in short-term borrowings.

D. Shortening of the cash conversion cycle.

Question: 11 The following information regards a change in credit policy. The company has a
required rate of return of 11% and a variable cost ratio of 50%.

Old New

Credit Policy Credit Policy

Sales $4,600,000 $4,960,000

Average collection period 30 days 35 days

The pre-tax cost of carrying the additional investment in receivables, assuming a 360-
day year, is

A. $5,439

B. $98,890

C. $13,778

D. $10,878

Question: 12 A firm that often factors its accounts receivable has an agreement with its finance
company that requires the firm to maintain a 6% reserve and charges 1% commission
on the amount of receivables. The net proceeds would be further reduced by an annual
interest charge of 10% on the monies advanced. Assuming a 360-day year, what
amount of cash (rounded to the nearest dollar) will the firm receive from the finance
company at the time a $100,000 account that is due in 90 days is turned over to the
finance company?

A. $93,000
 B. $90,000

C. $83,700

D. $90,675

Question: 13 A company with $4.8 million in credit sales per year plans to relax its credit standards,
projecting that this will increase credit sales by $720,000. The company’s average
collection period for new customers is expected to be 75 days, and the payment
behavior of the existing customers is not expected to change. Variable costs are 80%
of sales. The firm’s opportunity cost is 20% before taxes. Assuming a 360-day year,
what is the company’s benefit (loss) on the planned change in credit terms?

A. $28,800

B. $144,000

C. $120,000

D. $0

Question: 14 A company’s budgeted sales for the coming year are $40,500,000, of which 80% are
expected to be credit sales at terms of n/30. The company estimates that a proposed
relaxation of credit standards will increase credit sales by 20% and increase the
average collection period from 30 days to 40 days. Based on a 360-day year, the
proposed relaxation of credit standards will result in an expected increase in the
average accounts receivable balance of

A. $900,000

B. $2,700,000

C. $1,620,000

D. $540,000

Question: 15 A financial manager for a jewelry distributor is analyzing the cost of offering a cash
discount to its credit policy. Currently, the firm’s sales terms are net 60 and virtually all
of its customers pay at the end of the 60 days. The manager estimates that if the firm
offers a 2/10 net 60 discount, the average collection time on its $5,000,000 annual
credit sales will drop to one month with 60% of its customers taking advantage of the
 discount. The distributor currently finances working capital with a revolving credit
agreement at 12%. Calculate the firm’s net cost of adding the cash discount to its credit
terms.

A. $822

B. $60,000

C. $49,315

D. $10,685

Question: 16 A company serves as a distributor of products by ordering finished products once a

quarter and using that inventory to accommodate the demand over the quarter. If it
plans to ease its credit policy for customers, the amount of products ordered for its
inventory every quarter will be

A. Increased to accommodate higher sales levels.

B. Unaffected if the JIT inventory control system is used.

C. Reduced to offset the increased cost of carrying accounts receivable.

D. Unaffected if safety stock is part of the current quarterly order.

Question: 17 A firm sells to retail stores on credit terms of 2/10, net 30. Daily sales average
150 units at a price of $300 each. All sales are on credit and 60% of customers take
the discount and pay on day 10 while the rest of the customers pay on day 30. The
amount of the firm’s accounts receivable that is paid within the discount period is

A. $990,000

B. $900,000

C. $810,000

D. $1,350,000

Question: 18 The following information regards a change in credit policy. The company has a
required rate of return of 10% and a variable cost ratio of 60%.
 Old Credit New Credit

Policy Policy

Sales $3,600,000 $3,960,000

Average collection period 30 days 36 days

The pre-tax cost of carrying the additional investment in receivables, using a 360-day
year, would be

A. $9,600

B. $5,760

C. $8,160

D. $960

Question: 19 A firm is going to begin factoring its accounts receivable and has collected information
on the following four finance companies:

Annual

Required Interest

Reserves Commissions Charge

Company A 6% 1.4% 15%

Company B 7% 1.2% 12%

Company C 5% 1.7% 20%

Company D 8% 1.0% 5%
Which company will give the firm the highest initial proceeds from a $100,000 account
due in 60 days? Assume a 360-day year.

A. Company C.

B. Company A.

C. Company D.

D. Company B.
Question: 20 A retail company analyst is comparing North Company to South Company. The analyst
notes that receivables for both companies’ private label credit cards have significantly
increased balances in the current year. North’s customers’ monthly payment averaged
15% of their balances, while South’s customers’ monthly payment averaged 22% of
their balances. What should the analyst conclude?

A. South Company has likely increased its prices higher than North Company.

B. North’s customers may be having a harder time paying down their credit card debt
than South’s customers.

C. North Company sells more high-volume, low-margin goods than South Company.

D. Both North Company and South Company have increased their prices in the current
period; however, South Company has a higher gross margin than North Company.

Question: 21 Powell Industries deals with customers throughout the country and is attempting to
more efficiently collect its accounts receivable. A major bank has offered to develop
and operate a lockbox system for Powell at a cost of $90,000 per year. Powell
averages 300 receipts per day at an average of $2,500 each. Its short-term interest
cost is 8% per year. Using a 360-day year, what reduction in average collection time
would be needed in order to justify the lockbox system?

A. 1.20 days.

B. 1.25 days.

C. 1.50 days.

D. 0.67 days.

Question: 22 A company is reviewing its trade credit policy with respect to the small retailers to
which it sells. Four plans have been studied and the results are as follows:

Annual Bad Collection Accounts

Plan Revenue Debt Costs Receivable Inventory

A $200,000 $ 1,000 $1,000 $20,000 $40,000

B 250,000 3,000 2,000 40,000 50,000

 C 300,000 6,000 5,000 60,000 60,000

D 350,000 12,000 8,000 80,000 70,000

The information shows how various annual expenses, such as bad debts and the cost
of collections, change as sales change. The average balance of accounts receivable
and inventory have also been projected. The cost of the product to the company is
80% of the selling price, after-tax cost of capital is 15%, and the effective income tax
rate is 30%. What is the optimal plan for the company to implement?

A. Plan A.

B. Plan B.

C. Plan C.

D. Plan D.

Question: 23 Which of the following represents a firm’s average gross receivables balance?

I. Days’ sales in receivables × Accounts receivable turnover.

II. Average daily sales × Average collection period.
III. Net sales ÷ Average gross receivables.

A. II only.

B. I and II only.
IV.

C. I only.

D. II and III only.

Question: 24 A company plans to tighten its credit policy. The new policy will decrease the average
number of days in collection from 75 to 50 days and will reduce the ratio of credit sales
to total revenue from 70% to 60%. The company estimates that projected sales will be
5% less if the proposed new credit policy is implemented. If projected sales for the
coming year are $50 million, calculate the dollar impact on accounts receivable of this
proposed change in credit policy. Assume a 360-day year.

A. $6,500,000 decrease.

B. $3,819,445 decrease.
 C. $3,333,334 decrease.

D. $18,749,778 increase.

Fact Pattern: The Frame Supply Company has just acquired a large account and needs to increase its
working capital by $100,000. The controller of the company has identified the four sources of funds
given below.
1. Pay a factor to buy the company’s receivables, which average $125,000 per month and have an average
collection period of 30 days. The factor will advance up to 80% of the face value of receivables at 10% and
charge a fee of 2% on all receivables purchased. The controller estimates that the firm would save $24,000 in
collection expenses over the year. Assume the fee and interest are not deductible in advance.
2. Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3. Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6 months.)
4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be required.
Assume a 360-day year in all of your calculations.

Question: 25 The cost of Alternative 1 to Frame Supply Company is

A. 10.0%

B. 8.5%

C. 13.2%

D. 16.0%

Question: 26 Consider the following factors affecting a company as it is reviewing its trade credit
policy.

I. Operating at full capacity.

II. Low cost of borrowing.
III. Opportunity for repeat sales.
IV. Low gross margin per unit.

Which of the above factors would indicate that the company should liberalize its credit
policy?

A. II and III only.

 B. III and IV only.

C. I, II, and III only.

D. I and II only.

Question: 27 A company is considering a change in its credit terms from n/20 to 3/10, n/20. The
company’s budgeted sales for the coming year are $20,000,000, of which 80% are
expected to be made on credit. If the new credit terms are adopted, management
estimates that discounts will be taken on 60% of the credit sales; however,
uncollectible accounts will be unchanged. The new credit terms will result in expected
discounts taken in the coming year of

A. $288,000

B. $600,000

C. $480,000

D. $360,000

Question: 28 A corporation has been advised by its accountant that the following four sales volumes could be achieved along
patterns and credit losses, depending on the company’s credit policy (in thousands).

Sales Volume 30 Days 60 Days 90 Days 120 Days Credit Losses

I. $520 $300 $100 $100 $ 0 $ 20

II. 630 200 200 100 100 30

III. 770 200 100 200 200 70

IV. 900 100 200 200 300 100

Assuming that the firm’s cost of capital is 20% and that all payments are made on the first possible day of the ag
maximize profit?

A. III.

B. II.
 C. I.

D. IV.

Question: 29 An organization would usually offer credit terms of 2/10, net 30 when

A. Most competitors are offering the same terms, and the organization has a shortage of
cash.

B. The cost of capital approaches the prime rate.

C. The organization can borrow funds at a rate exceeding the annual interest cost.

D. The organization can borrow funds at a rate less than the annual interest cost.

Question: 30 An aging of accounts receivable measures the

A. Average length of time that receivables have been outstanding.

B. Amount of receivables that have been outstanding for given lengths of time.

C. Ability of the firm to meet short-term obligations.

D. Percentage of sales that have been collected after a given time period.

Question: 31A firm that often factors its accounts receivable has an agreement with its finance company that
requires the firm to maintain a 6% reserve and charges a 1.4% commission on the amount of the receivables. The net
proceeds would be further reduced by an annual interest charge of 15% on the monies advanced. Assuming a 360-
day year, what amount of cash (rounded to the nearest dollar) will the firm receive from the finance company at the
time a $100,000 account that is due in 60 days is turned over to the finance company?

A. $96,135

B. $90,285

C. $92,600

D. $85,000
Question: 32 A company believes that its collection costs could be reduced through modification of
collection procedures. This action is expected to result in a lengthening of the average
collection period from 28 days to 34 days; however, there will be no change in
uncollectible accounts. The company’s budgeted credit sales for the coming year are
$27,000,000, and short-term interest rates are expected to average 8%. To make the
changes in collection procedures cost beneficial, the minimum savings in collection
costs (using a 360-day year) for the coming year would have to be

A. $36,000

B. $360,000

C. $180,000

D. $30,000

Question: 33 A company had total sales of $500,000 in the first quarter of the year, which was the
same amount as it recorded in the first quarter of the prior year. However, its accounts
receivable balance increased from $230,000 last year to $300,000 this year. Which
one of the following is the most likely explanation for the increase in the accounts
receivable balance?

A. The company hired more people in its credit and collections department.

B. The company initiated the use of factoring in the current year.

C. The company discontinued the use of factoring in the current year.

D. The company shortened its payment terms in the current year from 60 days to 30
days.

Question: 34A firm currently has a conservative credit policy and is in the process of reviewing three other credit
policies. The current credit policy (Policy A) results in sales of $12 million per year. Policies B and C involve higher
sales, accounts receivable and inventory balances, as well as higher bad debt and collection costs. Policy D grants
longer payment terms than Policy C, but charges customers interest if they take advantage of the lengthy payment
terms. The policies are outlined below:

Policy ($000)

A B C D

Sales $12,000 $13,000 $14,000 $14,000

Average accounts receivable 1,500 2,000 3,500 5,000
Average inventory 2,000 2,300 2,500 2,500
Interest income 0 0 0 500
Bad debt expense 100 125 300 400
Collection cost 100 125 250 350
If the direct cost of products is 80% of sales and the cost of short-term funds is 10%, what is the optimal policy?

A. Policy A.

B. Policy B.

C. Policy D.

D. Policy C.

Question: 35A company offers all customers trade credit terms of 2/15, net 60. Currently, 30% of sales receipts
are paid with the discount applied. If the company were to change its credit terms, a change to which one of the
following terms is most likely to cause the company’s average collection period to decrease?

A. 2/15, net 30.

B. 1/15, net 30.

C. 1/15, net 90.

D. 1/15, net 60.

Question: 36 A maker of bowling gloves is investigating the possibility of liberalizing its credit policy.
Currently, payment is made on a cash-on-delivery basis. Under a new program, sales
would increase by $80,000. The company has a gross profit margin of 40%. The
estimated bad debt loss rate on the incremental sales would be 6%. Ignoring the cost
of money, what would be the return on sales before taxes for the new sales?

A. 34.0%

B. 40.0%

C. 36.2%

D. 42.5%
Question: 37 A company has the opportunity to increase annual sales by $100,000 by selling to a
new, riskier group of customers. Based on sales, the uncollectible expense is expected
to be 15%, and collection costs will be 5%. The company’s manufacturing and selling
expenses are 70% of sales, and its effective tax rate is 40%. If the company accepts
this opportunity, after-tax profit will increase by

A. $6,000

B. $9,000

C. $4,000

D. $10,000

Question: 38 A company’s budgeted sales for the coming year are expected to be $50,000,000, of
which 75% are expected to be credit sales at terms of n/30. The company estimates
that a proposed relaxation of credit standards will increase credit sales by 25% and
increase the average collection period from 20 days to 30 days. Based on a 360-day
year, the proposed relaxation of credit standards will result in an expected increase in
the average accounts receivable balance of

A. $3,906,250

B. $520,833

C. $1,822,917

D. $2,083,333

Question: 39 The sales manager feels confident that, if the credit policy were changed, sales would
increase and, consequently, the company would utilize excess capacity. The two credit
proposals being considered are as follows:

Proposal A Proposal B

Increase in sales $500,000 $600,000

Contribution margin 20% 20%

Bad debt percentage 5% 5%

Increase in operating profits $ 75,000 $ 90,000

Desired return on sales 15% 15%

 Currently, payment terms are net 30. The proposed payment terms for Proposal A and
Proposal B are net 45 and net 90, respectively. An analysis to compare these two
proposals for the change in credit policy would include all of the following
factors except the

A. Bank loan covenants on days’ sales outstanding.

B. Cost of funds.

C. Current bad debt experience.

D. Impact on the current customer base of extending terms to only certain customers.

Question: 40 A company is considering a change in its credit terms from n/30 to 2/10, n/30. The
company’s budgeted sales for the coming year are $24,000,000, of which 90% are
expected to be made on credit. If the new credit terms are adopted, the company
estimates that discounts will be taken on 50% of the credit sales; however,
uncollectible accounts will be unchanged. The new credit terms will result in expected
discounts taken in the coming year of

A. $432,000

B. $216,000

C. $480,000

D. $240,000
5: (31) Inventory Management

Question: 1 Using the standard economic order quantity (EOQ) model, if the EOQ for Product A is
200 units and a 50-unit safety stock is maintained for the item, what is the average
inventory of Product A?

A. 125 units.

B. 250 units.

C. 100 units.

D. 150 units.

Question: 2 The result of the economic order quantity (EOQ) formula indicates the

A. Annual usage of materials during the year.

B. Quantity of each individual order during the year.

C. Safety stock plus estimated inventory for the year.

D. Annual quantity of inventory to be carried.

Question: 3All of the following are inventory carrying costs except

A. Insurance.

B. Inspections.

C. Storage.

D. Opportunity cost of inventory investment.

Question: 4 A firm calculates that its annual cost to hold excess goods in order to avoid any chance
of running out of inventory is $50,000. This $50,000 is an example of a

A. Stockout cost.
 B. Carrying cost.

C. Quality cost.

D. Prime cost.

Question: 5 The new manager of inventory at a major retailer is developing an inventory control
system and knows he should consider establishing a safety stock level. The safety
stock can protect against all of the following risks except for the possibility that

A. The distribution of daily sales will have a large variance due to holidays, weather,
advertising, and weekly shopping habits.

B. Customers cannot find the merchandise they want, and they will go to the
competition.

C. New competition may open in the company’s market area.

D. Shipments of merchandise from the manufacturers is delayed by as much as 1 week.

Question: 6 The carrying costs associated with inventory management include

A. Obsolescence, set-up costs, capital invested, and purchasing costs.

B. Purchasing costs, shipping costs, set-up costs, and quantity discounts lost.

C. Storage costs, insurance costs, capital invested, and obsolescence.

D. Insurance costs, shipping costs, storage costs, and obsolescence.

Question: 7The amount of inventory that a company would tend to hold in safety stock would increase as the

A. Cost of carrying inventory decreases.

B. Sales level falls to a permanently lower level.

C. Variability of sales decreases.

D. Cost of running out of stock decreases.

Question: 8 The basic Economic Order Quantity (EOQ) model includes which of the following
assumptions?

I. The same fixed quantity is ordered at each reorder point.

II. Purchasing costs are unaffected by the quantity ordered.
III. Purchase order lead-time is known with certainty.
IV. Adequate inventory is always maintained to avoid stockouts.

A. I and IV only.

B. I, II, III, and IV.

V.

C. I, II, and IV only.

D. II and III only.

Question: 9 The controller at a chain of hardware stores wants to determine the optimum safety
stock levels for an air purifier unit. The inventory manager compiled the following data:

• The annual carrying cost of inventory approximates 20% of the investment in

inventory.
• The inventory investment per unit averages $50.
• The stockout cost is estimated to be $5 per unit.
• The company orders inventory on the average of 10 times per year.
• Total cost = carrying cost + expected stockout cost.
• The probabilities of a stockout per order cycle with varying levels of safety
stock are as follows:

Units

Safety Resulting

Stock Stockout Probability

200 0 0%

100 100 15%

 0 100 15%

0 200 12%
The total cost of safety stock on an annual basis with a safety stock level of 100 units is

A. $1,750

B. $2,000

C. $550

D. $1,950

Question: 10 A major supplier has offered a corporation a year-end special purchase whereby it
could purchase 180,000 cases of sport drink at $10 per case. The corporation normally
orders 30,000 cases per month at $12 per case. The corporation’s cost of capital is
9%. In calculating the overall opportunity cost of this offer, the cost of carrying the
increased inventory would be

A. $81,000

B. $32,400

C. $64,800

D. $40,500

Question: 11 Which one of the following would not be considered a carrying cost associated with
inventory?

A. Insurance costs.

B. Cost of obsolescence.

C. Shipping costs.

D. Cost of capital invested in the inventory.

Question: 12 When the economic order quantity (EOQ) model is used for a firm that manufactures
its inventory, ordering costs consist primarily of
 A. Insurance and taxes.

B. Storage and handling.

C. Obsolescence and deterioration.

D. Production set-up.

Question: 13 Which one of the following statements concerning the economic order quantity (EOQ)
is correct?

A. The EOQ model assumes that order delivery times are consistent.

B. The EOQ model assumes constantly increasing usage over the year.

C. Increasing the EOQ is the best way to avoid stockouts.

D. The EOQ results in the minimum ordering cost and minimum carrying cost.

Question: 14 A review of inventories reveals the following cost data for entertainment centers.

Invoice price $400.00 per unit

Freight and insurance on shipment 20.00 per unit

Insurance on inventory 15.00 per unit

Unloading 140.00 per order

Cost of placing orders 10.00 per order

Cost of capital 25%

What are the total carrying costs of inventory for an entertainment center?

A. $115

B. $105

C. $120

D. $420
Question: 15 All of the following are carrying costs of inventory except

A. Shipping costs.

B. Insurance.

C. Opportunity costs.

D. Storage costs.

Question: 16 Using the economic order quantity (EOQ) model, a decrease in which one of the
following variables would increase the EOQ?

A. Safety stock level.

B. Carrying costs.

C. Annual sales.

D. Cost per order.

Question: 17 Assume that the following inventory values are determined to be appropriate:

Sales 1,000 units

Carrying costs 20% of inventory value

Purchase price $10 per unit

Cost per order $10

What is the economic order quantity (EOQ)?

A. 100 units.

B. 141 units.

C. 45 units.
 D. 1,000 units.

Question: 18 During inflationary periods, last-in, first-out inventory accounting will generally have a

A. Higher cost of goods sold and lower inventory value.

B. Lower cost of goods sold and lower inventory value.

C. Lower cost of goods sold and higher inventory value.

D. Higher cost of goods sold and higher inventory value.

Question: 19 In a just-in-time production system, costs per setup were reduced from $28 to $2. In
the process of reducing inventory levels, it was found that there were fixed facility and
administrative costs that previously had not been included in the carrying cost
calculation. The result was an increase from $8 to $32 per unit per year. What were the
effects of these changes on the economic lot size and relevant costs?
Lot Size Relevant Costs

A. Increase Increase

B. Decrease Decrease

C. Decrease Increase

D. Increase Decrease

Question: 20 The following information regarding inventory policy was assembled. The company
uses a 50-week year in all calculations.

Sales 12,000 units per year

Order quantity 4,000 units

Safety stock 1,500 units

Lead time 5 weeks

The reorder point is
 A. 2,700 units.

B. 240 units.

C. 1,200 units.

D. 5,500 units.

Question: 21 The level of safety stock in inventory management depends on all of the
following except the

A. Level of customer dissatisfaction for back orders.

B. Cost of running out of inventory.

C. Level of uncertainty of the sales forecast.

D. Cost to reorder stock.

Question: 22 An entity uses 400 lbs. of a rare isotope per year. The isotope costs $500 per lb., but
the supplier is offering a quantity discount of 2% for order sizes between 30 and 79
lbs. and a 6% discount for order sizes of 80 lbs. or more. The ordering costs are $200.
Carrying costs are $100 per lb. of material and are not affected by the discounts. If the
purchasing manager places eight orders of 50 lbs. each, the total cost of ordering and
carrying inventory, including discounts lost, will be

A. $12,100

B. $6,600

C. $4,100

D. $1,600

Question: 23 A distributor is reviewing its inventory policy with respect to safety stocks of its most
popular product. Four safety stock levels were analyzed and annual stockout costs
estimated for each level.

Safety Stock Stockout Costs

 1,000 units $3,000

1,250 units 2,000

1,500 units 1,000

2,000 units 0
The cost of this product is $20 per unit, holding costs are 4% per year, and the cost of
short-term funds is 10% per year. What is the optimal safety stock level?

A. 1,250 units.

B. 1,500 units.

C. 2,000 units.

D. 1,000 units.

Question: 24 In inventory management, the safety stock will tend to increase if the

A. Variability of the usage rate decreases.

B. Variability of the lead time increases.

C. Carrying cost increases.

D. Cost of running out of stock decreases.

Question: 25 An example of a carrying cost is

A. Spoilage.

B. Disruption of production schedules.

C. Handling costs.

D. Quantity discounts lost.

Question: 26 A company expects to use 48,000 gallons of paint per year costing $12 per gallon.
Inventory carrying cost is equal to 20% of the purchase price. The company uses its
 inventory at a constant rate. The lead time for placing the order is 3 days, and the
company holds 2,400 gallons of paint as safety stock. If the company orders 2,000
gallons of paint per order, what is the cost of carrying inventory?

A. $5,280

B. $8,160

C. $5,760

D. $2,400

Question: 27 Which one of the following is not explicitly considered in the standard calculation of
economic order quantity (EOQ)?

A. Level of sales.

B. Carrying costs.

C. Fixed ordering costs.

D. Quantity discounts.

Question: 28 An inventory management technique designed to minimize inventory investment by

having materials arrive at the time they are needed for use is known as

A. First-in first-out (FIFO).

B. Materials requirements planning (MRP).

C. The economic order quantity model (EOQ).

D. Just-in-time (JIT).

Question: 29 The economic order quantity for a product is 500 units. However, new orders require 4
working-days lead time during which 80 units will be used. Given this information, the
correct economic order quantity is

A. 420 units.
 B. 509 units.

C. 580 units.

D. 500 units.

Question: 30 Using the economic order quantity (EOQ) model as part of its inventory control
program, an increase in which one of the following variables would increase the EOQ?

A. Purchase price per unit.

B. Carrying cost rate.

C. Safety stock level.

D. Ordering costs.

Question: 31 The optimal level of inventory is affected by all of the following except the

A. Cost per unit of inventory.

B. Current level of inventory.

C. Cost of placing an order for merchandise.

D. Usage rate of inventory per time period.