Create an account
a. Spontaneous Financing
b. Spontaneous financing is the amount of working capital that arises naturally in the ordinary course of business without the firm's financial managers needing to take deliberate action.
c. Trade credit arises when a company is offered credit terms by its suppliers.
d. Accrued expenses, such as salaries, wages, interest, dividends, and taxes payable, are another source of (interest-free) spontaneous financing.
e. The portion of capital needs that cannot be satisfied through spontaneous means must be the subject of careful financial planning
Conservative Policy to financing
A firm that adopts a conservative working capital policy seeks to minimize liquidity risk by holding a greater proportion of permanent working capital.
Aggressive Policy financing
a. An aggressive working capital policy involves reducing liquidity and accepting a higher risk of short-term cash flow problems in an effort to increase profitability.
Reasons to hold cash according to Keynes 3
1. the transactional motive to use as a medium of exchange
2. precautionary motive to provide a cushion for the unexpected
3. speculative motive-to take advantage of unexpected opportunities
demand (checking) account. Compensating balances are noninterest¬bearing and are meant to compensate the bank for various services rendered, such as unlimited check writing.
. A draft is a three-party instrument in which one person (the drawer) orders a second person (the drawee) to pay money to a third person (the payee).
payable through draft
payable through draft
(PTD) differs from a check in that (1) it is not payable on demand and (2) the drawee is the payor, not a bank. After the payee presents the PTD to a bank, the bank in turn presents it to the issuer. The issuer then must deposit sufficient funds to cover the PTD. Use of PTDs thus allows a firm to maintain lower cash balances.
A zero-balance account (ZBA) carries, as the name implies, a balance of $0. At the end of each processing day, the bank transfers just enough from the firm's master account to cover all checks presented against the ZBA that day.
1) This practice allows the firm to maintain higher balances in the master account from which short-term investments can be made. The bank generally charges a fee for this service.
Disbursement float is the period of time from when the payor puts a check in the mail until the funds are deducted from the payor's account. In an effort to stretch disbursement float, a firm may mail checks to its vendors while being unsure that sufficient funds will be available to cover them all
1) Treasury bills
2) Treasury notes
3) Treasury bonds
1) Treasury bills (T-bills) have maturities of 1 year or less. Rather than bear interest, they are sold on a discount basis.
2) Treasury notes (T-notes) have maturities of 1 to 10 years. They provide the lender with a coupon (interest) payment every 6 months.
3) Treasury bonds (T-bonds) have maturities of 10 years or longer. They provide the lender with a coupon (interest) payment every 6 months.
Repurchase agreements (repos) are a means for dealers in government securities to finance their portfolios. When a company buys a repo, the firm is temporarily purchasing some of the dealer's government securities. The dealer agrees to repurchase them at a later time for a specific (higher) price.
Bankers' acceptances are drafts drawn by a nonfinancial firm on deposits at a bank. The acceptance by the bank is a guarantee of payment at maturity. The payee can thus rely on the creditworthiness of the bank rather than on that of the (presumably riskier) drawer. Because they are backed by the prestige of a large bank, these
instruments are highly marketable once they have been accepted.
Commercial paper consists of unsecured, short-term notes issued by large companies that are very good credit risks.
f. Certificates of deposit
f. Certificates of deposit (CDs) are a form of savings deposit that cannot be withdrawn before maturity without a high penalty. CDs often yield a lower return than commercial paper because they are less risky. Negotiable CDs are traded under the regulation of the Federal Reserve System.
Basic Receivables Formula
-AVG days outstanding
The most common credit terms offered are 2/10, net 30. This is a convention meaning that the customer may either deduct 2% of the invoice amount if the invoice is paid within 10 days or pay the entire balance by the 30th day
account receivable, therefore, is outstanding for 28 days [(10 days × 20%) + (30 days × 60%) + (40 days × 20%)].
-AVG accounts receivable
balance in receivables = Daily credit sales x Avg. collection period
Step 1-28 days [(10 days × 20%) + (30 days × 60%) + (40 days × 20%)].
Step 2. The firm in the previous example has $15,000 in daily sales on credit. The firm's average balance in receivables is thus $420,000 ($15,000 × 28 days). So the 15,000 daily credit sales is a known variable
Average balance in receivables formula use knowns from previous
The firm has annual credit sales of $5,400,000. The firm's average balance in receivables is thus $420,000 [$5,400,000 × (28 days ÷ 360 days)].
Accounts receivable turnover use previous example known variable
A/R turnover ratio
The firm turned its accounts receivable over 12.9 times during the year ($5,400,000 ÷ $420,000).
Costs related to inventory
1) Purchase costs
2) Carrying costs
3) Ordering costs
4) Stockout costs
1) Purchase costs are the actual invoice amounts charged by suppliers. This is also referred to as investment in inventory.
2) Carrying costs is a broad category consisting of all those costs associated with holding inventory: storage, insurance, security, inventory taxes, depreciation or rent of facilities, interest, obsolescence and spoilage, and the opportunity cost of funds tied up in inventory. This is sometimes stated as a percentage of investment in inventory.
3) Ordering costs are the fixed costs of placing an order with a vendor, independent of the number of units ordered. For internally manufactured units, these consist of the set-up costs of a production line.
4) Stockout costs are the opportunity cost of missing a customer order. These can also include the costs of expediting a special shipment necessitated by insufficient inventory on hand.
Accordingly, safety stock is an inventory buffer held as a hedge against contingencies. Determining the appropriate level of safety stock involves a probabilistic calculation that balances the variability of demand with the level of risk the firm is willing to accept of having to incur stockout costs.
The reorder point is established with the following equation (Average daily demand x Lead time in days) + Safety stock
Non-value adding activities
2) JIT is a pull system
2) JIT is a pull system, meaning it is demand-driven: In a manufacturing environment, production of goods does not begin until an order has been received. In this way, finished goods inventories are also eliminated.
3) A backflush costing system
3) A backflush costing system is often used in a JIT environment. Backflush costing eliminates the traditional sequential tracking of costs. Instead, entries to inventory may be delayed until as late as the end of the period.
1) Kanban means ticket. Tickets (also described as cards or markers) control the flow of production or parts so that they are produced or obtained in the needed amounts at the needed times.
2) A basic kanban system includes a withdrawal kanban that states the quantity that a later process should withdraw from its predecessor, a production kanban that states the output of the preceding process, and a vendor kanban that tells a vendor what, how much, where, and when to deliver.
A firm's operating cycle is the amount of time that passes between the acquisition of inventory and the collection of cash on the sale of that inventory.
1) The (overlapping) steps in the operating cycle are
a) Acquisition of inventory and incurrence of a payable
b) Settlement of the payable
c) Holding of inventory
d) Selling of inventory and incurrence of a receivable
e) Collection on the receivable and acquisition of further inventory
Which one of the following provides a spontaneous source of financing for a firm?
A. Accounts payable.
B. Mortgage bonds.
C. Accounts receivable.
Answer (A) is correct. Trade credit is a spontaneous source of financing because it arises
automatically as part of a purchase transaction. Because of its ease in use, trade credit is
the largest source of short-term financing for many firms both large and small.
Net working capital is the difference between
Current assets and current A. liabilities
Net working capital is defined by accountants as the difference
between current assets and current liabilities. Working capital is a measure of short-term
Recording the payment (as distinguished from the declaration) of a cash dividend, the
declaration of which was already recorded, will
Increase the current ratio but have no effect A. on working capital.
B. Decrease both the current ratio and working capital.
C. Increase both the current ratio and working capital.
D. Have no effect on the current ratio or earnings per share.
Answer (A) is correct. The payment of a previously declared cash dividend reduces
current assets and current liabilities equally. An equal reduction in current assets and
current liabilities causes an increase in a positive (greater than 1.0) current ratio.
Depoole's payment of a trade account payable of $64,500 will
Increase the current ratio, but the quick ratio would A. not be affected.
B. Increase the quick ratio, but the current ratio would not be affected.
C. Increase both the current and quick ratios.
D. Decrease both the current and quick ratios.
The current ratio and the quick ratio will increase.
Answer (C) is correct. Given that the quick assets exceed current liabilities, both the
current and quick ratios exceed 1 because the numerator of the current ratio includes other
current assets in addition to the quick assets of cash, net accounts receivable, and shortterm
marketable securities. An equal reduction in the numerator and the denominator,
such as a payment of a trade payable, will cause each ratio to increase.
Depoole's purchase of raw materials for $85,000 on open account will
A. Increase the current ratio.
B. Decrease the current ratio.
C. Increase net working capital.
D. Decrease net working capital.
Answer (B) is correct. The purchase increases both the numerator and denominator of the
current ratio by adding inventory to the numerator and payables to the denominator.
Because the ratio before the purchase was greater than 1, the ratio is decreased
Obsolete inventory of $125,000 was written off by Depoole during the year. This transaction
A. Decreased the quick ratio.
B. Increased the quick ratio.
C. Increased net working capital.
D. Decreased the current ratio
Answer (D) is correct. Writing off obsolete inventory reduced current assets, but not
quick assets (cash, receivables, and marketable securities). Thus, the current ratio was
reduced and the quick ratio was unaffected.
Depoole's issuance of serial bonds in exchange for an office building, with the first installment
of the bonds due late this year,
Decreases net A. working capital.
B. Decreases the current ratio.
C. Decreases the quick ratio.
D. Affects all of the answers as indicated.
(d) The first installment is a current liability; thus the amount of
current liabilities increases with no corresponding increase in current assets. The effect is
to decrease working capital, the current ratio, and the quick ratio.
Depoole's early liquidation of a long-term note with cash affects the
A. Current ratio to a greater degree than the quick ratio.
B. Quick ratio to a greater degree than the current ratio.
C. Current and quick ratio to the same degree.
D. Current ratio but not the quick ratio.
Answer (B) is correct. The numerators of the quick and current ratios are decreased when
cash is expended. Early payment of a long-term liability has no effect on the denominator
(current liabilities). Since the numerator of the quick ratio, which includes cash, net
receivables, and marketable securities, is less than the numerator of the current ratio,
which includes all current assets, the quick ratio is affected to a greater degree.
North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit.
Belle's quick ratio is significantly better than the industry average. Which of the following
factors should North consider as a possible limitation of using this ratio when evaluating
Fluctuating market prices of short-term investments may adversely A. affect the ratio.
B. Increasing market prices for Belle's inventory may adversely affect the ratio.
C. Belle may need to sell its available-for-sale investments to meet its current obligations.
D. Belle may need to liquidate its inventory to meet its long-term obligations.
Answer (A) is correct. The quick ratio equals current assets minus inventory, divided by
current liabilities. Because short-term marketable securities are included in the numerator,
fluctuating market prices of short-term investments may adversely affect the ratio if Belle
holds a substantial amount of such current assets.
Windham Company has current assets of $400,000 and current liabilities of $500,000.
Windham Company's current ratio will be increased by
A. The purchase of $100,000 of inventory on account.
B. The payment of $100,000 of accounts payable.
C. The collection of $100,000 of accounts receivable.
D. Refinancing a $100,000 long-term loan with short-term debt.
Answer (A) is correct. The current ratio equals current assets divided by current
liabilities. An equal increase in both the numerator and denominator of a current ratio less
than 1.0 causes the ratio to increase. Windham Company's current ratio is .8 ($400,000 ÷
$500,000). The purchase of $100,000 of inventory on account would increase the current
assets to $500,000 and the current liabilities to $600,000, resulting in a new current ratio
Given an acid test ratio of 2.0, current assets of $5,000, and inventory of $2,000, the value of
current liabilities is
The acid test or quick ratio equals the ratio of the quick assets
(cash, net accounts receivable, and marketable securities) divided by current liabilities.
Current assets equal the quick assets plus inventory and prepaid expenses. This question
assumes that the entity has no prepaid expenses. Given current assets of $5,000, inventory
of $2,000, and no prepaid expenses, the quick assets must be $3,000. Because the acid test
ratio is 2.0, the quick assets are double the current liabilities. Current liabilities therefore
are equal to $1,500 ($3,000 quick assets ÷ 2.0).
Bond Corporation has a current ratio of 2 to 1 and a (acid test) quick ratio of 1 to 1. A
transaction that would change Bond's quick ratio but not its current ratio is the
Sale of inventory A. on account at cost.
B. Collection of accounts receivable.
C. Payment of accounts payable.
D. Purchase of a patent for cash.
Answer (A) is correct. The quick ratio is determined by dividing the sum of cash, shortterm
marketable securities, and accounts receivable by current liabilities. The current ratio
is equal to current assets divided by current liabilities. The sale of inventory (a nonquick
current asset) on account would increase cash (a quick asset), thereby changing the quick
ratio. The sale of inventory for cash, however, would be replacing one current asset with
another, and the current ratio would be unaffected
Rice, Inc. uses the allowance method to account for uncollectible accounts. An account
receivable that was previously determined uncollectible and written off was collected during
May. The effect of the collection on Rice's current ratio and total working capital is
The entry to record this transaction is to debit receivables, credit
the allowance, debit cash, and credit receivables. The result is to increase both an asset
(cash) and a contra asset (allowance for bad debts). These appear in the current asset
section of the balance sheet. Thus, the collection changes neither the current ratio nor
working capital because the effects are offsetting. The credit for the journal entry is made
to the allowance account on the assumption that another account will become
uncollectible. The company had previously estimated its bad debts and established an
appropriate allowance. It then (presumably) wrote off the wrong account. Accordingly, the
journal entry reinstates a balance in the allowance account to absorb future uncollectibles
Merit, Inc. uses the direct write-off method to account for uncollectible accounts receivable. If
the company subsequently collects an account receivable that was written off in a prior
accounting period, the effect of the collection of the account receivable on Merit's current ratio
and total working capital would be
Because the company uses the direct write-off method, the original
entry involved a debit to a bad debt expense account (closed to retained earnings). The
subsequent collection required a debit to cash and a credit to bad debt expense or retained
earnings. Thus, only one current asset account was involved in the collection entry, and
current assets (cash) increased as a result. If current assets increase and no change occurs
in current liabilities, the current ratio and working capital both increase.
Corp declares and two weeks later pays dividend, how do both incidents effect current ratio.
Decreased by the dividend declaration and increased by the A. dividend payment.
Which one of the following would increase the net working capital of a firm?
Cash payment of payroll A. taxes payable.
B. Purchase of a new plant financed by a 20-year mortgage.
C. Cash collection of accounts receivable.
D. Refinancing a short-term note payable with a 2-year note payable.
Answer (D) is correct. Net working capital equals current assets minus current liabilities.
Refinancing a short-term note with a 2-year note payable decreases current liabilities, thus
increasing working capital.
Badoglio Co.'s current ratio is 3:1. Which of the following transactions would normally
increase its current ratio?
Purchasing inventory A. on account.
B. Selling inventory on account.
C. Collecting an account receivable.
D. Purchasing machinery for cash.
Answer (B) is correct. The current ratio is equal to current assets divided by current
liabilities. Given that the company has a current ratio of 3:1, an increase in current assets
or decrease in current liabilities would cause this ratio to increase. If the company sold
merchandise on open account that earned a normal gross margin, receivables would be
increased at the time of recording the sales revenue in an amount greater than the decrease
in inventory from recording the cost of goods sold. The effect would be an increase in the
current assets and no change in the current liabilities. Thus, the current ratio would be
According to John Maynard Keynes, the three major motives for holding cash are for
John Maynard Keynes, founder of Keynesian economics,
concluded that there were three major motives for holding cash: for transactional purposes
as a medium of exchange, precautionary purposes, and speculative purposes (but only
during deflationary periods).
An increase in sales resulting from an increased cash discount for prompt payment would be
expected to cause a(n)
Increase in the A. operating cycle.
B. Increase in the average collection period.
C. Decrease in the cash conversion cycle.
D. Decrease in purchase discounts taken.
Answer (C) is correct. If the cause of increased sales is an increase in the cash discount, it
can be inferred that the additional customers would pay during the discount period. Thus,
cash would be collected more quickly than previously and the cash conversion cycle
would be shortened
1. Net credit sales=500k
2. net sales =250k
Jan 1 75k
dec 31 50k
What is a/r turnover for the year?
projected sales collection
1. 40% by 15 day discount date
2. 40% by 30 due date
3. 20% 15 days late
What is the projected sales outstanding?
multiply together like WAC you get 27 days.
Yonder Motors sells 20,000 automobiles per year for $25,000 each. The firm's average
receivables are $30,000,000 and average inventory is $40,000,000.Yonder's average collection
period is closest to which one of the following? Assume a 365-day year.
Average collection period = Days in year ÷ Accounts receivable turnover
= 365 ÷ (Net credit sales ÷ Average net receivables)
= 365 ÷ [(20,000 × $25,000) ÷ $30,000,000]
= 365 ÷ ($500,000,000 ÷ $30,000,000)
= 365 ÷ 16.667
= 21.9 days
Which of the following assumptions is associated with the economic order quantity formula?
The carrying cost per unit will vary with A. quantity ordered.
B. The cost of placing an order will vary with quantity ordered.
C. Periodic demand is known.
D. The purchase cost per unit will vary based on quantity discounts.
Answer (C) is correct. The economic order quantity (EOQ) model is a mathematical tool
for determining the order quantity that minimizes the sum of ordering costs and carrying
costs. The following assumptions underlay the EOQ model: (1) Demand is uniform;
(2) Order (setup) costs and carrying costs are constant; and (3) No quantity discounts are
As a consequence of finding a more dependable supplier, Dee Co. reduced its safety stock of
raw materials by 80%. What is the effect of this safety stock reduction on Dee's economic order
The variables in the EOQ formula are periodic demand, cost per
order, and the unit carrying cost for the period. Thus, safety stock does not affect the
EOQ. Although the total of the carrying costs changes with the safety stock, the costminimizing
order quantity is not affected
corp just instituted Just in time production system, cost per order has been reduced from 28 to 2 dollars, fixed facility and admin cost increased 2 to 32, how does this effect lot size and relevant cost.
The economic lot size for a production system is similar to the
EOQ. For example, the cost per set-up is equivalent to the cost per order (a numerator
value in the EOQ model). Hence, a reduction in the setup costs reduces the economic lot
size as well as the relevant costs. The fixed facility and administrative costs, however, are
not relevant. The EOQ model includes variable costs only.
The carrying costs associated with inventory management include
Storage costs, handling costs, capital invested, and obsolescence.
The ordering costs associated with inventory management include
Ordering costs are costs incurred when placing and receiving
orders. Ordering costs include purchasing costs, shipping costs, setup costs for a
production run, and quantity discounts lost
1. in avg weekly demand
2. explain reorder formula
1. (Sales/weeks in year)
2. Reorder point = (Average weekly demand × Lead time) + Safety stock
The level of safety stock in inventory management depends on all of the following except the
Level of uncertainty of A. the sales forecast.
B. Level of customer dissatisfaction for back orders.
C. Cost of running out of inventory.
D. Cost to reorder stock.
Answer (D) is correct. Determining the appropriate level of safety stock involves a
complex probabilistic calculation that balances (1) the variability of demand for the good,
(2) the variability in lead time, and (3) the level of risk the firm is willing to accept of
having to incur stockout costs. Thus, the only one of the items listed that does not affect
the level of safety stock is reorder costs.
The result of the economic order quantity (EOQ) formula indicates the
The EOQ model is a deterministic model that calculates the ideal
order (or production lot) quantity given specified demand, ordering or setup costs, and
carrying costs. The model minimizes the sum of inventory carrying costs and either
ordering or production setup costs.
Key Co. changed from a traditional manufacturing operation with a job-order costing system to
a just-in-time operation with a backflush costing system. What are the expected effects of these
changes on Key's inspection costs and recording detail of costs tracked to jobs in process?
JIT system, materials go directly into production without
being inspected. The assumption is that the vendor has already performed all necessary
inspections. The minimization of inventory reduces the number of suppliers, storage costs,
transaction costs, etc. Backflush costing eliminates the traditional sequential tracking of
costs. Instead, entries to inventory may be delayed until as late as the end of the period.
For example, all product costs may be charged initially to cost of sales, and costs may be
flushed back to the inventory accounts only at the end of the period. Thus, the detail of
cost accounting is decreased.
To determine the inventory reorder point, calculations normally include the
A. Ordering cost.
B. Carrying cost.
C. Average daily usage.
D. Economic order quantity.
Answer (C) is correct. The reorder point is the amount of inventory on hand indicating
that a new order should be placed. It equals the sales per unit of time multiplied by the
time required to receive the new order (lead time).
Accounts receivable turnover ratio will normally decrease as a result of
The write-off of an uncollectible account (assume the use of the allowance for doubtful
B. A significant sales volume decrease near the end of the accounting period.
C. An increase in cash sales in proportion to credit sales.
D. A change in credit policy to lengthen the period for cash discounts.
Answer (D) is correct. The accounts receivable turnover ratio equals net credit sales
divided by average receivables. Hence, it will decrease if a company lengthens the credit
period or the discount period because the denominator will increase as receivables are
held for longer times
Inventory turnover ratio formula?
Cost of goods sold/ ( avg inventory. (current former year inventory/ 2)
Yr 1 a/r = 60
Yr 2 a/r =90
Sales = 600
1. What is a/r turnover
2. what is it in days?
What ratio's do you need to find operating cycle?
1. time from purchase of inventory to collection of cash
operating cycle = sum of number of days sales in inventory and teh number of days' sales in receivables.
The theory underlying the cost of capital is primarily concerned with the cost of:
a. Long-term funds and old funds.
b. Short-term funds and new funds.
c. Long-term funds and new funds.
d. Any combination of old or new, short-term or long-term funds.
Choice "d" is correct. The cost of capital considers the cost of all funds - whether they are short-term, longterm
, new or old.
Sylvan Corporation has the following capital structure:
The financial leverage of Sylvan Corp. would increase as a result of:
a. Issuing common stock and using the proceeds to retire preferred stock.
b. Issuing common stock and using the proceeds to retire debenture bonds.
c. Financing its future investments with a higher percentage of bonds.
d. Financing its future investments with a higher percentage of equity funds.
Choice "c" is correct. Financial leverage increases when the debt to equity ratio increases. Using a higher
percentage of debt (bonds) for future investments would increase financial leverage.
Residual income is a better measure for performance evaluation of an investment center manager than return
on investment because:
a. The problems associated with measuring the asset base are eliminated.
b. Desirable investment decisions will not be neglected by high-return divisions.
c. Only the gross book value of assets needs to be calculated.
d. The arguments about the implicit cost of interest are eliminated.
Choice "b" is correct. Residual income measures actual dollars that an investment earns over its required
return rate. Performance evaluation on this basis will mean that desirable investment decisions will not be
rejected by high-return divisions.
The basic objective of the residual income approach of performance measurement and evaluation is to have
a division maximize its:
a. Return on investment rate.
b. Imputed interest rate charge.
c. Cash flows in excess of a desired minimum amount.
d. Income in excess of a desired minimum amount.
Choice "d" is correct. Residual income is defined as income
Capital investments require balancing risk and return. Managers have a responsibility to ensure that theinvestrnents that they make in their own firms increase shareholder value. Managers have met that responsibility if the return on the capital investment:
a. Exceeds the rate of return associated with the firm's beta factor.
b. Is less than the rate of return associated with the firm's beta factor.
c. Is greater than the prime rate of return.
d. Is less than the prime rate of return
Choice "a" is correct. A capital investment whose rate of return exceeds the rate of return associated with the
firm's beta factor will increase the value of the firm.
The Stewart Co. uses the Economic Order Quantity (EOQ) model for inventory management. A decrease in
which one of the following variables would increase the EOQ?
a. Cost per order.
b. Safety stock leve l.
c. Carrying costs.
d. Quantity demanded.
Choice "c" is correct. A decrease in carrying costs would increase the Economic Order Quantity (EOQ).
Annual Sales quantity in units
Cost per purchase Qrder
Annual cost of Carrying one unit in stock for one year
Order size gets larger as "S" or "0" gets bigger (numerator) or as "C" gets smaller (denominator).
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. Permanent current assets with short-term debt.
d. Fluctuating current assets with short-term debt.
Choice "c" is correct. The working capital financing policy that finances permanent current assets with shortterm
debt subjects the firm to the greatest risk of being unable to meet the firm's maturing obligations.
Calculate ROI Yr2 Yr3
Revenue 900k 1,100k
Expense 650k 700k
Assets 1,200k 2,000k
YR2 +YR3 / 2 =1,600k
Which of the following inventory management approaches orders at the point where carrying costs equate
nearest to restocking costs in order to minimize total inventory cost?
a. Economic order quantity.
c. Materials requirements planning.
Choice "a" is correct. The economic order quantity (EOO) method of inventory control anticipates orders at
the point where carrying costs are nearest to restocking costs. The objective of EOO is to minimize total
inventory costs. The formula for EOO is:
What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to
evaluate the performance of investment center managers?
a. ROI is a percentage, while RI is a dollar amount.
b. ROI may lead to rejecting projects that yield positive cash flows .
c. ROI does not necessarily reflect the company's cost of capital.
d. ROI does not reflect all economic gains.
Choice "b" is correct. The primary disadvantage of using return on investment (ROI) rather than residual
income (RI) to evaluate the performance of investment center managers is that ROI may lead to rejecting
projects that yield positive cash fiows . Profitable investment center managers might be reluctant to invest in
projects that might lower their ROI (especially if their bonuses are based only on their investment center's
ROI), even though those projects might generate positive cash flows for the company as a whole. This
characteristic is often known as the "disincentive to invest."
Amicable Wireless, Inc. offers credit terms of 2/1 0, net 30 for its customers. Sixty percent of Amicable's
customers take the 2% discount and pay on day 10. The remainder of Amicable's customers pay on day 30.
How many days' sales are in Amicable's accounts receivable?
Choice "c" is correct. Days' sales in accounts receivable is normally calculated as Days' sales = Ending
accounts receivable 1 Average daily sales. However, that formula will not work in this case because the
necessary information is not provided. However, enough information about payments is provided so that the
total days' sales can be determined on a weighted average basis. In this question, nobody pays before the
10th day and 60% of the customers pay on the 10th day, so there are 10 x .60, or 6 day's sales there. The
other 40% of the customers pay on the 30th day so there are 30 x AD, or 12 day's sales there. The total is 18
Why would a firm want to finance temporary assets with short-term debt
Choice "a" is correct. Matching the maturities of current assets with liabilities as they come due is designed to
ensure liquidity and reduce risk of cash shortages. Temporary assets (such as inventories, generally, and
seasonal inventories, specifically) might be financed with short term debt such that the earnings from the
sales of those temporary assets could be used to liquidate the related obligations as they come due and
ensure that cash is available to meet cash flow requirements.
Which of the following rates is most commonly compared to the internal rate of return to evaluate whether to
make an investment?
a. Short-term rate on U.S. Treasury bonds.
b. Prime rate of interest.
c. Weighted-average cost of capital.
d. Long-term rate on U.S. Treasury bonds.
Choice "c" is correct. The weighted-average cost of capital is frequently used as the hurdle rate within capital
budgeting techniques. Investments that provide a return that exceeds the weighted-average cost of capital
should continuously add to the value of the firm.
Which of the following assumptions is associated with the economic order quantity formula?
a. The carrying cost per unit will vary with quantity ordered.
b. The cost of placing an order will vary with quantity ordered.
c. Periodic demand is known.
d. The purchase cost per unit will vary based on quantity discounts.
Choice "c" is correct. The economic order quantity formula (EOQ) assumes that periodic demand is known .
Annual sales volume is a crucial variable in the EOQ formula .
Which of the following types of bonds is most likely to maintain a constant market value?
Choice "b" is correct. Floating-rate bonds would automatically adjust the return on a financial instrument to
produce a constant market value for that instrument. No premium or discount would be required since market
changes would be accounted for through the interest rate.
Capital budgeting decisions include all but which of the following?
a. Selecting among long-term investment alternatives.
b. Financing short-term working capital needs.
c. Making investments that produce returns over a long period of time.
d. Financing large expenditures.
Choice "b" is correct. Capital budgeting decisions do not include the financing of short-term working capital
needs, which are more operational in nature.
Which one of the following is most relevant to a manufacturing equipment replacement decision?
a. Original cost of the old equipment.
b. Disposal price of the old equipment.
c. Gain or loss on the disposal of the old equipment.
d. A lump-sum write-off amount from the disposal of the old equipment.
Choice "b" is correct. The disposal price of the old equipment is most relevant because it is an expected
future inflow that will differ among alternatives. If this old equipment is replaced , there will be a cash inflow
from the sale of the old equipment. If the old equipment is kept, there will be no cash inflow from the sale of
the old equipment.
All of the following items are included in discounted cash flow analysis, except:
a. Future operating cash savings.
b. The current asset disposal price.
c. The future asset depreciation expense.
d. The tax effects of future asset depreciation.
Choice "c" is correct. The future asset depreciation expense is not included in discounted cash flow analysis.
• Future operating cash savings
• Current asset disposal price
• Tax effects of future asset depreciation
• Future asset disposal price
All of the following are the rates used in net present value analysis, except for the:
a. Cost of capital.
b. Hurdle rate.
c. Discount rate.
d. Accounting rate of return .
Choice "d" is correct. The accounting rate of return is a capital budgeting technique, not a rate.
• Cost of capital
• Hurdle rate
• Discount rate
• Required rate of return
The net present value (NPV) of a project has been calculated to be $215,000. Which one of the following
changes in assumptions would decrease the NPV?
a. Decrease the estimated effective income tax rate.
b. Extend the project life and associated cash inflows.
c. Increase the estimated salvage value.
d. Increase the discount rate.
Choice "d" is correct. An increase in the discount rate will decrease the present value of future cash inflows
and, therefore, decrease the net present value of the project.
Andrew Corporation is evaluating a capital investment that would result in a $30,000 higher contribution
margin benefit and increased annual personnel costs of $20,000. The effects of income taxes on the net
present value computation on these benefits and costs for the project are to:
a. Decrease both benefits and costs.
b. Decrease benefits but increase costs.
c. Increase benefits but decrease costs.
d. Increase both benefits and costs.
Choice "a" is correct. The effects of income taxes on the net present value computations will decrease both
benefits and costs for the project. Net present value computations focus of the present value of cash flows.
Income taxes decrease both the benefit and the cost of cash flows .
The internal rate of return for a project can be determined:
a. Only if the project cash flows are constant.
b. By finding the discount rate that yields a net present value of zero for the project.
c. By subtracting the firm's cost of capital from the project's profitability index.
d. Only if the project's profitability index is greater than one.
Choice "b" is correct. The internal rate of return (IRR) is the discount rate that produces a NPV of zero.
The internal rate of return is the:
a. Rate of interest that equates the present value of cash outflows and the present value of cash inflows.
b. Risk-adjusted rate of return.
c. Required rate of return.
d. Weighted average rate of return generated by internal funds.
Choice "a" is correct. The internal rate of return is defined as the technique that determines the present value
factor such that the present value of the after-tax cash flows equals the initial investment on the project.
Alternately, the internal rate of return (IRR) is the discount rate that produces a NPV of zero.
Do you use NPV in calculating payback period?
do you use salvage value in factoring payback period ?
NO DUMB ASS
NO DUMB ASS
When evaluating capital budgeting analysis techniques, the payback period emphasizes:
c. Net income.
d. The accounting period .
Choice "a" is correct. The payback period is the time period required for cash inflows to recover the initial
investment. The emphasis of the technique is on liquidity (i.e., cash flow) .
The term underwriting spread refers to the:
a. Commission percentage an investment banker receives for underwriting a security lease.
b. Discount investment bankers receive on securities they purchase from the issuing company.
c. Difference between the price the investment banker pays for a new security issue and the price at which
the securities are resold .
d. Commission a broker receives for either buying or selling a security on behalf of an investor.
Choice "c" is correct. Investment bankers are paid their fees partly by being allowed to purchase the new
securities they are underwriting for a discount and then reselling those securities on the market. This is
known as the underwriting spread.
A firm with a higher degree of operating leverage when compared to the industry average implies that the:
a. Firm has higher variable costs.
b. Firm's profits are more sensitive to changes in sales volume.
c. Firm is more profitable.
d. Firm uses a significant amount of debt financing.
Choice "b" is correct. A firm with a higher degree of operating leverage when compared to the industry
average implies that the firm's profits are more sensitive to changes in sales volume.
Rule: Operating leverage is the presence of fixed costs in operations, which allows a small change in sales to
produce a larger relative change in profits.
Which of the following transactions does not change the current ratio and does not change the total current
a. A cash advance is made to a divisional office.
b. A cash dividend is declared.
c. Short-term notes payable are retired with cash.
d. Equipment is purchased with a three-year note and a 10 percent cash down payment.
Choice "a" is correct. This does not change the current ratio because the reduction of cash is offset by an
increase in accounts receivable
An increase in sales collections resulting from an increased cash discount for prompt payment would be
expected to cause a (n):
a. Increase in the operating cycle.
b. Increase in the average collection period.
c. Decrease in the cash conversion cycle.
d. Increase in bad debt losses.
Choice "a" is correct. This does not change the current ratio because the reduction of cash is offset by an
increase in accounts receivable
Which one of the following represents methods for converting accounts receivable to cash?
a. Trade discounts, collection agencies, and credit approval.
b. Factoring, pledging, and electronic funds transfers.
c. Cash discounts, collection agencies, and electronic funds transfers.
d. Trade discounts, cash discounts, and electronic funds transfers.
Choice "c" is correct. The following are methods of converting accounts receivable (AR) into cash:
1. Collection agencies - used to collect overdue AR.
2. Factoring AR - selling AR to a factor for cash.
3. Cash discounts - offering cash discounts to customers for paying AR quickly (or paying at all). For
example: 2/10, net 30.
4. Electronic fund transfers - a method of payment, which electronically transfers funds between banks.
Which one of the following statements concerning cash discounts is correct?
a. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
b. With trade terms of 2/15, net 60, if the discount is not taken , the buyer receives 45 days of free credit.
c. The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
d. The cost of not taking a cash discount is generally higher than the cost of a bank loan.
Choice "d" is correct. The cost of not taking a cash discount is generally higher than the cost of a bank loan.
Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable certificates
a. Have a secondary market for investors.
b. Are regulated by the Federal Reserve System.
c. Are usually sold in denominations of a minimum of $100,000.
d. Have yields considerably greater than bankers' acceptances and commercial paper.
Choice "d" is correct. Negotiable CDs generally carry interest rates slightly lower than bankers' acceptances
(which are drafts drawn on deposits at a bank) or commercial paper (which is unsecured debt issued by credit
All of the following are alternative marketable securities suitable for investment, except:
b. Commercial paper.
c. Bankers' acceptances.
d. Convertible bonds.
Choice "d" is correct. Convertible bonds. Temporarily idle cash should be inverted in very liquid , low risk
short-term investments only. U.S. T-bills are basically risk-free. Banker's acceptances and Eurodollars are
only slightly more risky. Commercial paper, the short-term unsecured notes of the most credit-worthy large
U.S. corporations is a little riskier, but still relatively low risk. However, convertible bonds are subject to
default risk, liquidity risk, and maturity (interest rate) risk, and as such are inappropriate securities for shortterm
marketable security investment.
Which one of the following responses is not an advantage to a corporation that uses the commercial paper
market for short-term financing?
a. The borrower avoids the expense of maintaining a compensating balance with a commercial bank.
b. There are no restrictions as to the type of corporation that can enter into this market.
c. This market provides a broad distribution for borrowing.
d. A benefit accrues to the borrower because its name becomes more widely known.
Choice "b" is correct. There are restrictions as to the type of corporation that can enter into the commercial
paper market for short-term financing , since the use of the open market is restricted to a comparatively small
number of the most credit-worthy large corporations.
The commercial paper market:
a. Avoids the expense of maintaining a compensating balance with a commercial bank.
c. Provides a broad distribution for borrowing.
d. Accrues a benefit to the borrower because its name becomes more widely known
Which of the following represents a firm's average gross receivable balance?
I. Days' sales in receivables x accounts receivable turnover.
II. Average daily sales x average collection period.
III. Net sales + average gross receivables.
a. I only.
b. I and II only.
c. II only.
d. II and III only.
Choice "c" is correct. II only - Average daily sales ($27,397) x Average collection period (36.5) = $1,000,000
Avg gross AIR
Which one of the following statements is most correct if a seller extends credit to a purchaser for a period of
time longer than the purchaser's operating cycle? The seller:
a. Will have a lower level of accounts receivable than those companies whose credit period is shorter than
the purchaser's operating cycle.
b. Is, in effect, financing more than just the purchaser's inventory needs.
c. Is, in effect, financing the purchaser's long-term assets.
d. Has no need for a stated discount rate or credit period.
Choice "b" is correct. If a seller extends credit to a purchaser for a period of time longer than the purchaser's
operating cycle, the seller is, in effect, financing more than just the purchaser's inventory needs.
Calculate reorder point:
50 week year
sales: 10,000 units per year
Order quantity: 2,000 units
Safety stock 1,300 units
lead-time 4 weeks
-50 week year would mean that 200units are sold a week,
-therefore 800 units are sold during lead-time 4*200,
-rq safety stock is 1,300 units.
Therefore: 1,300+800 units = 2,100 is reorder point.
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