CH 10 - Working Capital Management

Test Bank Chapter 22: WORKING CAPITAL MANAGEMENT EFS
I. True or False (Definitions and Concepts)
F 1. Working capital management includes several basic business relationships

including the sales impact and liquidity, but not the relations with stakeholders. (FALSE: Should
be and relations with stakeholders instead of but not the relations with stakeholders.)
T 2. Working capital management consists of managing a firm's current assets and

current liabilities (where current refers to one year or less).
T 3. In the maturity-matching approach, the firm hedges its risk by matching the
maturities of its assets and liabilities.
F 4. The cash conversion cycle is the length of time between the payment of accounts
payable and the receipt of cash from marketable securities. (FALSE: Should be from accounts
receivable instead of from marketable securities.)
T 5. The receivables collection period is the average number of days that it takes to
collect on accounts receivable.
F 6. A transaction balance is an account balance that the firm agrees to maintain.

(FALSE: Should be compensation instead of transaction.)
F 7. The precautionary demand is based on the desire to take advantage of unexpected

profitable opportunities that require cash. (FALSE: Should be speculative instead of
precautionary.)
T 8. U.S. federal agency securities are backed by U.S. government but give slightly
higher rates that U.S. Treasury securities.
T 9. Cash and marketable securities are managed together.
F 10. Commercial papers are drafts that a commercial bank has "accepted." (FALSE:
Should be Bankers' acceptances instead of Commercial paper.)
T 11. Commercial paper has an original maturity of more than 270 days.
F 12. The cash conversion cycle is equal to the inventory conversion period plus the
receivables collection period plus the payables deferral period. (FALSE: Should be minus the
payables deferral period instead of plus the payables deferral period.)
T 13. Electronic data interchange is the direct exchange of information between the
computers of two businesses.
F 14. Optimal deposit size is the difference between the checking account balance at
the bank and the balance on the firm's ledgers. (FALSE: Should be Float instead of Optimal
deposit size.)
T 15. Trade credit, bank loans, and commercial paper are the main sources of short-
term financing.
II. Multiple Choice (Definitions and Concepts)
b 16. The Baumol cash management model assumes .

a. the firm cannot predict its future cash requirements with certainty.
b. the cash disbursements are spread uniformly over the period.
c. the interest rate (the opportunity cost of holding cash) is not fixed.
d. all of these
b 17. The Miller-Orr cash management model .

a. is less realistic than the Baumol model.
b. allows the daily cash flow to vary according to a probability function.
c. uses one control limit and a return point.
d. is a good example of management by inclusion.
d 18. Firms use several devices and procedures to manage float including .
a. lockboxes.
b. zero balance accounts.
c. controlled disbursing.
d. all of these
a 19. Main sources of short-term funds include .

a. trade credit and commercial paper.
b. futures and bank loans.
c. bonds and trade credit.
d. none of these
b 20. Bank term loans represent .

a. long-term loans that looks like short-term debt.
b. loans for specified amounts that require borrowers to repay them according to
specified schedules.
c. the pledge of receivables.
d. the difference between the available or collected balance at the bank and the
firm’s book (or ledger) balance.
a 21. Electronic data interchange (EDI) allows the exchange of information

electronically from one computer to another thereby .
a. saving personnel costs.
b. increasing material costs.
c. completely eliminating errors.
d. a&c
a 22. says to compare the benefits and costs of alternative uses and sources
of money using after-tax APYs.
a. The Principle of Time Value of Money
b. The Signaling Principle
c. The Principle of Incremental Benefits
d. The Options Principle
b 23. says to calculate the incremental after-tax cash flows connected with
working capital decisions.
a. The Signaling Principle
b. The Principle of Incremental Benefits
c. The Principle of Time Value of Money
a 24. says not to act unethically to gain short-term profit at the expense of a
supplier or a customer, because such behavior can damage or even destroy a profitable long-term
relationship.
a. The Principle of Two-Sided Transactions
b. The Self-Interest Principle
c. The Signaling Principle
d. The Principle of Comparative Advantage
d 25. says to look for hidden options and recognize their value, such as the
option to refinance long-term debt.
b. The Principle of Time Value of Money
c. The Capital Market Efficiency Principle
c 26. says to periodically evaluate routine capital market alternatives to

make sure they continue to be competitive.
b. The Behavioral Principle
c. The Capital Market Efficiency Principle
d. The Risk-Return Trade-Off Principle
c 27. is based on the desire to take advantage of unexpected profitable

opportunities that require cash.
a. The precautionary demand
b. The transactions demand
c. The speculative demand
d. The accounting demand
a 28. is essentially the margin of safety required to meet unexpected needs.

a. The precautionary demand
b. The transactions demand
c. The speculative demand
d. The accounting demand
d 29. The transactions demand .

a. is based on the desire to take advantage of unexpected profitable opportunities
that require cash.
b. exists because of imbalances between cash inflows and outflows.
c. depends on the relative timing of cash inflows and outflows.
d. all of these
d 30. Which of the following statements is false?

a. Treasury bills (T-bills) have an original maturity of one year or less when they
are issued.
b. Treasury notes and bonds have an original maturity of one year or more.
c. Negotiable CDs are time deposits issued by domestic or foreign commercial
banks that can be sold to a third party.
d. Munis are long-term securities, issued by state and local governments, and are
exempt from federal taxation.
a 31. Which of the following statements is false?

a. Bankers' acceptances are unsecured promissory notes that corporations issue.
b. Preferred stock pays dividends that qualify for the 70% dividends-received
deduction.
c. Money-market preferred stock is a short-term security that has a floating
dividend rate that is reset frequently to reflect current interest rates.
d. U.S. federal agency securities are backed to varying degrees by the U.S.
government.
d 32. Which of the following statements is false?

a. The Baumol model has a sawtooth pattern of cash balances.
b. The Miller-Orr model uses two control limits and a return point.
c. The Baumol and Miller-Orr models deal with optimizing a firm's cash
transactions balances.
d. The optimal amount of marketable securities is the total liquidity desired plus
cash balances.
c 33. is the difference between the available or collected balance at the

bank and the firm's ledger balance.
a. Controlled disbursing
b. Lockboxes
c. Float
d. Zero balance accounts
d 34. These are special disbursement accounts that maintain a zero balance.
a. Wire transfers
b. Lockboxes
c. Collection Float
d. none of these
b 35. This technique may use disbursing accounts at several banks in addition to the
master account at the firm's lead bank.
a. Available balance
b. Controlled disbursing
c. Disbursement float
d. Zero balance accounts
a 36. Which of the following statements is true?

a. Trade credit is credit extended by one firm to another.
b. Businesses do not routinely grant trade credit on the sales of their goods and
services.
c. When trade credit is extended, the buyer specifies the period of time allowed for
payment.
d. The terms "2/10, net 30" mean the buyer can take a 2% cash discount if payment
is made within 30 days (the discount period).
a 37. Which of the following statements about trade credit is false?
a. Trade credit is the largest single source of short-term funds for businesses,
representing approximately two-third of the current liabilities of nonfinancial corporations.
b. If no discount is offered, or if payment is made soon enough that the discount can
be taken, there is no cost to the firm for the use of the supplier's trade credit.
c. The terms "2/10, net 30" mean the buyer can take a 2% cash discount if payment
is made within 10 days (the discount period).
d. Trade credit is also more flexible than other means of short-term financing.
b 38. Which of the following statements is false?

a. Firms may "stretch" accounts payable by postponing payment beyond the end of
the net period.
b. Stretching the payments on accounts payable is a good example of the Principle
of Signaling.
c. Commercial bank lending is second in importance to trade credit as a source of
short-term financing.
d. A line of credit is an arrangement between a bank and a customer concerning the
maximum loan balance the bank will permit the borrower at any one time.
b 39. Which of the following statements is true?

a. Banks make a transaction loan for general purposes.
b. A revolving credit agreement represents a legal commitment to lend up to a
specified maximum amount any time during a specified period.
c. Bank term loans always represent short-term loans with less than one-year
maturity.
d. A 3-year revolving credit convertible into a 5-year term loan at the end of the
third year is uncommon.
a 40. Which of the below statements is false?

a. For commercial bank loans, the interest rate rarely floats with the bank's prime
rate, which is a benchmark rate that banks may use to price loans
b. Except for a rather small percentage of loans that bear interest at a fixed rate,
commercial banks charge interest at a rate that floats.
c. Many loans are discount loans, which require the borrower to pay the interest in
advance.
d. Commercial banks often ask lenders to provide security for their loans.
c 41. Which of the below statements is false?

a. Commercial paper is sold either directly or through dealers.
b. The credit quality of commercial paper is rated by agencies such as Moody’s
Investors Service and Standard & Poor’s Corporation.
c. The cost of each source of funds is the only factor affecting a firm’s choice of
amount and mix of short-term debt as well as the overall maturity structure of the firm’s debt.
d. A wide variety of documents can be electronically exchanged with the structured
formats in EDI.
d 42. The Capital Market Efficiency Principle says .

a. to periodically evaluate routine capital market alternatives to make sure they
continue to be competitive.
b. to be careful to distinguish between routine transactions made in an efficient
capital market, and unique transactions that are not subjected to such intense competition.
c. that decisions to grant credit or to use a particular supplier are essentially private,
and so the prices and risks should be checked against those in a competitive marketplace.
d. all of these
a 43. says that decisions to grant credit or to use a particular supplier are
essentially private, and so the prices and risks should be checked against those in a competitive
marketplace.
a. The Capital Market Efficiency Principle
b. The Signaling Principle
c. The Self-Interest Principle
d. The Behavioral Principle
c 44. says to use common industry practices as a starting place for

operating efficiently.
a. The Capital Market Efficiency Principle
b. The Risk-Return Trade-Off Principle
c. The Behavioral Principle
d. The Principle of Comparative Advantage
III. Multiple Choice (Problems)
a 45. Assume you skip the discount and pay at the end of the net period for the
following credit terms: 1/10, net 22. Calculate the APR for the trade credit.
a. about 30.72%
b. about 31.42%
c. about 31.72%
d. about 35.76%.
[ANSWER: The APR for trade credit is: APR =
(Discount% / [100% – Discount%])(365 / [Total period – Discount period]) =
(1% / [100% – 1%])(365 days / [22 days – 10 days]) = (1 / 99) (365 / 12) = 365 / [(99)(12)] =
365 / 1188 = 0.307239 or about 30.72%.]
d 46. Assume you skip the discount and pay at the end of the net period for the
following credit terms: 1/10, net 22. Calculate the APY for the trade credit.
a. about 30.72%
b. about 31.42%
c. about 35.46%
d. about 35.76%.
[ANSWER: The APY for trade credit is: APY =
(1 + [Discount% / {100% – Discount%}])(365 / [Total period – Discount period]) – 1 =
(1 + [1% / {100% – 1%}])(365 days / [22 days – 10 days]) – 1 = (1.010101)(30.416667) – 1 =
1.3575715 – 1 = 0.3575715 or about 35.76%.]
a 47. You need to transfer $250,000 from Houston to Chicago. If you mail a check, it
will cost $1.00 for postage and clearing the check, and it will take a total of five days for the
funds to be transferred. During the money's 5-day travel, you will suffer an opportunity cost,
because the $250,000 is not earning 3% APY interest. Alternatively, you can avoid the
opportunity cost by sending a wire transfer costing $12.00, which instantaneously transfers the
funds with no float. Which of the below statements is true?
a. To compare the two alternatives, we can use the equation: Cost = Fixed cost +
Float costs.
b. The cost of check is about $103.74 and the cost of wire transfer is $13.
c. The cost of check is the cheapest because it has the lower fixed cost.
d. The cost of check is about $102.74 and the cost of wire transfer is $12.
[ANSWER: To compare alternatives, we can use the equation: Cost = Fixed cost + Float costs.
Cost of check = Fixed cost + Float costs = $1.00 + $250,000(0.03)(5 / 365) = $1.00 + $102.73974
= $103.73973 or about $103.74. Cost of wire transfer = Fixed cost + Float costs = $12.00 + $0 =
$12.00. While the cost of check has lower fixed costs, it has much higher float costs. The wire
transfer is the cheapest with the major reason being that its float costs are zero.]
b 48. Suppose you are offered trade credit terms of 1.5/15, net 50. What is the APR
cost of this trade credit if you skip the discount and pay at the end of the net period?
a. 15.48%
b. 15.88%
c. 16.48%
d. 16.88%
(1.5% / [100% – 1.5%])(365 days / [50 days – 15 days]) = (1.5 / 98.5)(365 / 35) = 0.1588107 or
about 15.88%.]
d 49. Suppose you are offered trade credit terms of 1.5/15, net 50. What would be the
APR cost if you "stretched" the payables and paid after 75 days?
a. 8.26%
b. 8.56%%
c. 8.96%
d. 9.26%
[ANSWER: When we stretch payables, we decrease the APR by increasing the number of days
before the firm has to pay. In this case, pay in 75 days instead of 50 days. The APR for trade
credit is: APR = (Discount% / [100% – Discount%])(365 / [Total period – Discount period]) =
(1.5% / [100% – 1.5%])(365 days / [75 days – 15 days]) = (1.5 / 98.5)(365 / 60) = 0.0926395 or
about 9.26%.]
a 50. Stony Products has an inventory turnover of twelve times per year. What is
Stony's inventory conversion period (ICP)?
a. about 30.42 days
b. about 31.50 days
c. about 40.83 days
d. none of these
[ANSWER: The inventory conversion period (ICP) is the average time between buying
inventory and selling the goods. We have: ICP = 365 days / ITO where ITO is the inventory
turnover and is equal to: CS / inventory where CS is cost of sales. We have: ICP = 365 days / ITO
= 365 days / 12 = 30.416667 or about 30.42 days.]
b 51. Stony Products has a receivables turnover of ten times. What is Stony’s
receivables collection period (RCP)?
a. about 35.42 days
b. about 36.50 days
c. about 40.83 days
d. none of these
[ANSWER: The receivables collection period (RCP), or days' sales outstanding (DSO), is the
average number of days that it takes to collect on accounts receivable. We have: RCP =
365 days / RTO where RTO is the receivables turnover and is equal to: sales / AR where AR is
account receivables. We have: RCP = 365 days / RTO = 365 days / 10 = 36.5 days.]
c 52. Stony Products has a payables turnover of six times. What is Stony's payables
deferral period (PDP)?
a. about 30.42 days
b. about 56.50 days
c. about 60.83 days
d. none of these
[ANSWER: The payables deferral period is the average length of time between the purchase of
the materials and labor that go into inventory and the payment of cash for these materials and
labor. We have: PDP = 365 days / PTO where PTO is the payables turnover and is equal to:
(CS + SGA) / (AP + WBT) where CS is cost of sales, SGA is selling, general, and administrative
expenses, AP is account payables, and WBT is wages, benefits, and payroll taxes payable. We
have: PDP = 365 days / PTO = 365 days / 6 = 60.83333 or about 60.83 days.]
b 53. Stony Products has an inventory conversion period (ICP) of about 60.83 days.
The receivables collection period (RCP) is 36.50 days. The payables deferral period (PDP) is
about 30.42 days. What is Stony's cash conversion cycle (CCC)?
a. about 66 days
b. about 67 days
c. about 68 days
d. about 69 days
[ANSWER: We have: CCC = ICP + RCP – PDP = 60.83 days + 36.50 days – 30.42 days = 66.91
or about 67 days.]
d 54. What is the effective annual cost of skipping the discount and paying at the end
of the net period for the following credit terms: 1/10, net 30?
a. about 10.13%
b. about 15.13%
c. about 18.43%
d. none of these
(1 + [1% / {100% – 1%}])(365 days / [30 days – 10 days]) – 1 = (1.010101)(18.25) – 1 = 1.2013 – 1 = 0.2013 or
about 20.13%.]
b 55. What is the effective annual cost of skipping the discount and paying at the end
of the net period for the following credit terms: 6/10, net 70?
a. about 38.83%
b. about 45.70%
c. about 48.83%
d. none of these
(1 + [6% / {100% – 6%}])(365 days / [70 days – 10 days]) – 1 = (1.0638298)(6.0833333) – 1 = 1.4570425 – 1 =
0.4570425 or about 45.70%.]
d 56. Suppose the Ruskin Oil Corporation has $150,000 for both its book balance and
its bank balance. It takes 4 days for a check to clear. If Ruskin writes a $3,000 check, which of
the following statements is false?
a. If Ruskin writes a $3,000 check that takes 4 days to clear, during this period,
$3,000 of disbursement float has been created.
b. Ruskin’s book balance declines by the amount of the check, from $150,000 to
$147,000, but the bank balance is unchanged until the check clears.
c. Ruskin’s available balance is $150,000, its book balance is $147,000, and its
disbursement float is $3,000.
d. After the check clears, the book and bank balances will both be $150,000 and
there is no more disbursement float.
[ANSWER: If Ruskin writes a $3,000 check that takes 4 days to clear, during this period, $3,000
of disbursement float has been created. Ruskin’s book balance declines by the amount of the
check, from $150,000 to $147,000, but the bank balance is unchanged until the check clears.
Ruskin’s float on this check can be found by using the float equation. We have:
Disbursement float = Available balance – Book balance = $150,000 – $147,000 = $3,000. After
the check clears, the book and bank balances will both be $147,000 and there is no more
disbursement float.]
b. 57. Ruskin has a $150,000 cash balance on both its ledger balance and its available
bank balance. If Ruskin receives a check and deposits it in its checking account, funds are not
made available on this particular check for 2 days. If Ruskin receives a $15,000 check, which of
the following statements is false?
a. Until the funds are credited to your account, your book balance will be higher
than your actual balance and the funds will not be available on the $15,000 check for 2 days.
b. Ruskin’s book balance decreases by $15,000, but its bank balance is unchanged
until the funds are finally available.
collection float is –$15,000.
d. The negative float of $15,000 is Ruskin's collection float.
[ANSWER: Float can be either positive or negative. Suppose you receive a check and deposit it
in your bank. Until the funds are credited to your account, your book balance will be higher than
your actual balance. In this case, you are experiencing collection float. If Ruskin receives a
$15,000 check and deposits it in its checking account, funds are not made available on this
particular check for 2 days. Its book balance increases by $15,000, but its bank balance is
unchanged until the funds are available. Ruskin’s float on this check can be found by using the
float equation. We have: Collection float = Available balance – Book balance =
$150,000 – $165,000 = –$15,000. This negative float of $15,000 is Ruskin's collection float.]
c 58. Gear Corporation currently collects all of its customer payments in Kansas City.
By going to a new lockbox system with boxes in Indianapolis and Denver, Gear expects to reduce
the time from when customers mail their checks to when the funds are collected. It expects the
time to fall from an average of 8 days to an average of 5 days, a 3-day savings. Gear collects
$50,000 per day. The extra costs associated with the lockbox are $8,000 per year. Gear’s
opportunity cost of funds is 10% per year. What is the expected annual profit of using the new
system?
a. $15,000
b. $8,000
c. $7,000
d. none of these
[ANSWER: Reduction in float = ($50,000 / day)(3 days) = $150,000. Value of float reduction =
$150,000(0.10) = $15,000. With an annual operating cost of $8,000, we have:
net before-tax profit from the lockbox system = $15,000 – $8,000 = $7,000.]
d 59. Gear Corporation currently collects all of its customer payments in Kansas City.
By going to a new lockbox system with boxes in Indianapolis and Denver, Gear expects to reduce
the time from when customers mail their checks to when the funds are collected. It expects the
time to fall from an average of 8 days to an average of 4 days, a 4-day savings. Gear collects
$50,000 per day. The extra costs associated with the lockbox are $10,000 per year. Gear’s
opportunity cost of funds is 10% per year. Which of the below statements is true?
a. The reduction in float is $200,000 and it permanently frees up this amount of
cash.
b. The value of the float reduction at 10% is $20,000 and the annual operating cost
is $10,000.
c. Subtracting the $10,000 yearly cost of operating the system gives an expected
before-tax profit of $10,000 per year.
d. all of these
net before-tax profit from lockbox system = $20,000 – $10,000 = $10,000. The reduction in float
of $200,000 permanently frees up this amount of cash. Invested at 10%, this is worth $20,000 per
year. Subtracting the $10,000 yearly cost of operating the system gives an expected before-tax
profit of $10,000 per year.]
a 60. Based on a 360-day year, what is the approximate APR if 120-day prime
commercial paper carries a 10% interest rate?
a. 10.34%
b. 11.22%
c. 12.06%
d. 12.58%
[ANSWER: Interest on commercial paper is paid on a discount basis. The APR interest cost
(based on a 360-day year) is: APR = r / [1 – r(f)]) = 0.10 / [1 – 0.10(120 / 360)] =
0.10 / [1 – 0.03333] = 0.10 / [0.966666] = 0.1034482 or about 10.34%.]
c 61. Rubric, Inc. issues $100M (M = million) of 90-day commercial paper at 10%.
How much does Rubric receive from the issue of commercial paper?
a. $95.5M
b. $96.5M
c. $97.5M
d. $100M
[ANSWER: For a 360-day year, 90 days becomes f = 0.25 of a year. The paper is discounted, so
Rubric receives $100M – [(r)(f)$100M] = $100M – [(0.10)(0.25) $100M] = $100M – $2.5M =
$97.5M.]
b 62. General Motors Acceptance Corporation (GMAC) issues $50M (M = million) of

90-day commercial paper at 10%. Which of the following statements is true?
a. GMAC receives $48.75M and the APR is 10.57%
b. GMAC receives $48.75M and the APR is 10.26%
c. GMAC receives $50.00M and the APR is 10.26%
d. none of these
GMAC receives $50M – [(r)(f)$50M] = $50M – [(0.10)(0.25) $50M] = $50M – $1.25M =
$48.75M. We have: APR = (net cost of loan / cash advance)(1 / f) = ($1.25M / $48.75M)(1 /
0.25) = (0.025641)(4) = 0.1025641 or about 10.26%]
d 63. Rubric, Inc. issues $50M (M = million) of 90-day commercial paper at 10%.
Rubric "rolls over" its paper four times per year, selling new commercial paper to replace each
issue as it matures. Which of the following statements is true?
a. Rubric receives $50.00M and the APY is 9.26%
b. Rubric receives $48.75M and the APY is 10.26%
c. Rubric receives $48.75M and the APY is 10.37%
d. Rubric receives $48.75M and the APY is 10.57%
Rubric receives $50M – [(r)(f)$50M] = $50M – [(0.10)(0.25) $50M] = $50M – $1.25M =
$48.75M. We have: APY = (1 + [net cost of loan / cash advance])(1 / f) – 1 =
(1 + [$1.25M / $48.75M]) (1 / 0.25) – 1 = (1 + [0.025641])4 – 1 = (1.025641)4 – 1 = 1.1065767 – 1 =
0.1056767 or about 10.57%.]
a 64. Gear Corporation currently collects all of its customer payments in Nashville. By
going to a new lockbox system with boxes in Chicago and Denver, Gear expects to reduce the
time from when customers mail their checks to when the funds are collected. It expects the time
to fall from an average of 9 days to an average of 4 days, a 5-day savings. Gear collects $50,000
per day. The extra costs associated with the lockbox are $15,000 per year. Gear’s opportunity
cost of funds is 10% per year. What is the expected annual profit of using the new system?
a. $10,000
b. $15,000
c. $25,000
d. none of these
net before-tax profit from the lockbox system = $25,000 – $15,000 = $10,000.]
d 65. Longhorn Corporation’s commercial paper has an APR cost of 9.26%. Assuming
a backup line of credit costing 0.25% of the funds received and that legal and other out-of-pocket
costs amounting to another 0.55% per year, what is Longhorn’s total APR?
a. 9.01%
b. 9.51%
c. 9.81%
d. 10.06%
[ANSWER: The total cost is: Cost = 9.26% + 0.25% + 0.55% = 10.06%.]
d 66. Suppose the Ruskin Oil Corporation has $90,000 for both its book balance and its
bank balance. It takes 4 days for a check to clear. If Ruskin writes a $5,000 check, which of the
following statements is true?
a. If Ruskin writes a $5,000 check that takes one week to clear, during this period,
$1,250 of disbursement float has been created.
b. Ruskin’s book balance declines by the amount of the check, from $90,000 to
$85,000, and the bank balance decreases by $5,000 until the check clears.
disbursement float is $1,250.
d. After the check clears, the book and bank balances will both be $85,000 and
there is no more disbursement float.
[ANSWER: If Ruskin writes a $5,000 check that takes 4 days to clear, during this period, $5,000
of disbursement float has been created. Ruskin’s book balance declines by the amount of the
check, from $90,000 to $85,000, but the bank balance is unchanged until the check clears.
Ruskin’s float on this check can be found by using the float equation. We have:
Disbursement float = Available balance – Book balance = $90,000 – $85,000 = $5,000. After the
check clears, the book and bank balances will both be $85,000 and there is no more disbursement
float.]
b 67. You need to transfer $100,000 from Los Angeles to Kansas City. If you mail a
check, it will cost $2.00 for postage and clearing the check, and it will take a total of two days for
the funds to be transferred. During the money's 2-day travel, you will suffer an opportunity cost,
because the $250,000 is not earning 1% APY interest. Alternatively, you can avoid the
opportunity cost by sending a wire transfer costing $14.96, which instantaneously transfers the
funds with no float. Which of the below statements is true?
a. The cost of check is the cheapest by about $1.48.
b. The wire transfer costs twice as much as the check.
c. The wire transfer is the cheapest. The major reason is that its float costs are zero
d. The cost of check is about $14.96.
[ANSWER: To compare alternatives, we can use the equation: Cost = Fixed cost + Float costs.
Cost of check = Fixed cost + Float costs = $1.00 + $100,000(0.01)(2 / 365) = $2.00 + $5.4794521
= $7.4794521 or about $7.48. Cost of wire transfer = Fixed cost + Float costs = $14.96 + $0 =
$14.96. Thus, the wire transfer costs twice as much as the check since 2($7.48) = $14.96. The
major reason is that the cost of wire transfer has greater fixed costs.]
d 68. Assume you skip the discount and pay at the end of the net period for the
following credit terms: 1/15, net 32. Calculate the APY for the trade credit.
a. about 20.69%
b. about 21.69%
c. about 22.08%
d. about 24.08%.
(1 + [1% / {100% – 1%}])(365 days / [32 days – 15 days]) – 1 = (1.010101)(21.470588) – 1 =
1.2408376 – 1 = 0.2408376 or about 24.08%.]
b 69. Assume you skip the discount and pay at the end of the net period for the
following credit terms: 1/15, net 32. Calculate the APR for the trade credit.
a. about 20.69%
b. about 21.69%
c. about 22.08%
d. about 24.08%.
(1% / [100% – 1%])(365 days / [32 days – 15 days]) = (1 / 99) (365 / 17) = 365 / [(99)(17)] =
365 / 1683 = 0.2168746 or about 21.69%.]
IV. Longer Problems
70. The Fuji Corporation is interested in examining its cash conversion cycle. Suppose a Fuji
manager has assembled the following data for your use: $1M (M = million) in inventory; $0.8M
in account receivables (AR); $0.4M in account payables (AP); $0.15M in wages, benefits, and
payroll taxes payable (WBT); $50M in sales; $20M in cost of sales (CS); and, $1.5M in selling,
general, and administrative expenses (SGA). Answer the below questions.
(1) Estimate the inventory conversion period (ICP).
(2) Estimate the receivables collection period (RCP).
(3) Estimate the payables deferral period (PDF).
(4) What is the cash conversion cycle (CCC)?
ANSWER: (1): The inventory conversion period (ICP) is the average time between buying
inventory and selling the goods. We have: ICP = inventory / (CS / 365 days) =
$1M / ($20M / 365) = 365 / 20M = 18.25 days. [Another definition uses the inventory turnover
(ITO) where ITO = CS / inventory = $20M / $1M = 20. We have: ICP = 365 days / ITO =
365 days / 20 = 18.25 days.]
ANSWER: (2): The receivables collection period (RCP), or days' sales outstanding (DSO), is the
AR / (sales / 365 days) = $0.8M / ($50M / 365) = 365 / 62.5 = 5.84 days. [Another definition
uses the receivables turnover (RTO) where RTO = sales / AR = $50M / $0.8M = 62.5. We have:
RCP = 365 days / RTO = 365 days / 62.5 = 5.84 days.]
ANSWER: (3): The payables deferral period (PDP) is [AP + WBT] / [(CS + SGA) / 365] days) =
[$0.4M + $0.15M] / [($20M + $1.5M) / 365 days] = [$0.55M] / [($21.5M) / 365 days] =
365 days / 39.090909 = 9.3372093 or about 9.34 days. [Another definition uses the payables
turnover (PTO) where PTO where payable turnover = (CS + SGA) / (AP + WBT) =
($20M + $1.5M) / ($0.4M + $0.15M) = $21.5M / $0.55M = 39.090909. We have: PDP =
365 days / PTO = 365 day / 39.090909 = 9.3372093 or about 9.34 days.]
ANSWER: (4): The cash conversion cycle (CCC) is equal to the inventory conversion period
(ICP), plus the receivables collection period (RCP), minus the payable deferral period (PDP). We
have: CCC = ICP + RCP – PDP = 18.25 days + 5.84 days – 9.34 days = 14.75 days.
71. The Mennen Corporation is interested in examining its cash conversion cycle. Suppose a
Mennen manager has assembled the following data for your use: $1M (M = million) in inventory;
$0.8M in account receivables (AR); $0.4M in account payables (AP); $0.15M in wages, benefits,
and payroll taxes payable (WBT); $25M in sales; $10M in cost of sales (CS); and, $1.5M in
selling, general, and administrative expenses (SGA). Answer the below questions.
(1) Estimate the inventory conversion period (ICP).
(2) Estimate the receivables collection period (RCP).
(3) Estimate the payables deferral period (PDF).
(4) What is the cash conversion cycle (CCC)?
ANSWER: (1): The inventory conversion period (ICP) is the average time between buying
inventory and selling the goods. We have: ICP = inventory / (CS / 365 days) =
$1M / ($10M / 365) = 365 / 10M = 36.5 days. [Another definition uses the inventory turnover
(ITO) where ITO = CS / inventory = $10M / $1M = 10. We have: ICP = 365 days / ITO =
365 days / 10 = 36.5 days.]
ANSWER: (2): The receivables collection period (RCP), or days' sales outstanding (DSO), is the
AR / (sales / 365 days) = $0.8M / ($25M / 365) = 365 / 31.25 = 11.68 days. [Another definition
uses the receivables turnover (RTO) where RTO = sales / AR = $25M / $0.8M = 31.25. We have:
RCP = 365 days / RTO = 365 days / 31.25 = 11.68 days.]
ANSWER: (3): The payables deferral period (PDP) is [AP + WBT] / [(CS + SGA) / 365 days] =
[$0.4M + $0.15M] / [($10M + $1.5M) / 365 days] = [$0.55M] / [($11.5M) / 365 days] =
365 days / 20.909091 = 17.456522 or about 17.46 days. [Another definition uses the payables
turnover (PTO) where PTO where payable turnover = (CS + SGA) / (AP + WBT) =
($20M + $1.5M) / ($0.4M + $0.15M) = $21.5M / $0.55M = 39.090909. We have: PDP =
365 days / PTO = 365 day / 20.909091 = 17.456522 or about 17.46 days.]
ANSWER: (4): The cash conversion cycle (CCC) is equal to the inventory conversion period
(ICP), plus the receivables collection period (RCP), minus the payable deferral period (PDP). We
have: CCC = ICP + RCP – PDP = 36.50 days + 11.68 days – 17.46 days = 30.72 days.
72. Ray Brooks has discussed a $250,000 one-year loan (P) with several different banks. He
has three alternatives: a, b, and c. For each alternative, Ray wants to know the APR and the APY
so he can determine which alternative is the cheapest. Answer the below questions.
(1) ) Alternative “a” is a 15% annual rate (r) on a simple interest loan (interest in arrears),
with no compensating balance (B). Interest in arrears means that the interest is paid at the end of
the year. Compute the APR and APY.
(2) Alternative “b” is an 11% annual rate (r) on a simple interest loan with interest due at
the end of the year and with a 20% compensating balance requirement. Compute the APR and
APY.
(3) Alternative “c” is a 14% annual rate on a discount loan with no compensating
balance. Interest is paid at the beginning of the year. Compute the APR and APY.
(4) Which alternative does Ray choose? Why?
ANSWER (1): For alternative “a,” we can use the following general formula: APR =
[interest charges / (loan amount – compensating balance)](1 / f) = [rP / (P – B)](1 / f) where r =
interest rate on the loan amount = 0.15; P = amount of loan = $250,000; rP = interest charges =
0.15($250,000) = $37,500; B = increase in the firm's average cash balances as a result of the
compensating balance requirement (or the decrease in the amount of the loan as the result of
paying interest at the beginning of the period) = 0; and, f = fraction of a year the loan is
outstanding = 1 year. Inserting our values for rP, P, B, and f into our equation, we have: APR =
[rP / (P – B)](1 / f) = [$37,500 / ($250,000 – 0)](1 / 1) = [$37,500 / $250,000](1) = [0.15](1) =
0.1500 or 15.00%.
With a “simple” annual interest loan, we have f is 1. Thus, the APY will be the same as the APR.
We will go ahead and show this. We use the following formula: APY =
(1 + [net cost of loan / (cash advance)])(1 / f)} – 1 = {(1 + [rP / (P – B)])(1 / f)} – 1. Expressing 1 as
(P – B) / (P – B), inserting the latter term for 1 in our equation, performing algebraic
manipulations, and recognizing the net repayment is P – B + rP, it can be shown that APY =
{(net repayment / cash advance)(1 / f)} – 1 = {([(P – B) + rP] / (P – B))(1 / f)} – 1. Inserting our
values, we have APY = {([($250,000 – 0) + $37,500] / ($250,000 – $0))(1 / 1)} – 1 =
($287,500 / $250,000)1 – 1 = (1.15)1 – 1.00 = 1.15 – 1.00 = 0.15 or 15.00%.
ANSWER (2): For alternative “b,” we can use the following general formula: APR =
0.11($250,000) = $27,500; B = increase in the firm's average cash balances because of the
compensating balance requirement = 0.2($250,000) = $50,000; and, f = fraction of a year the loan
is outstanding = 1 year. Inserting our values for rP, P, B, and f into our equation, we have: APR =
[rP / (P – B)](1 / f) = [$27,500 / ($250,000 – $50,000)](1 / 1) = [$27,500 / $200,000](1) =
[0.1375](1) = 0.1375 or 13.75%.
With a “simple” annual interest loan, we have f is 1. Thus, the APY will be the same as the APR.
We will go ahead and show this. We use the following formula: APY =
values, we have APY = {([($250,000 – $50,000) + $27,500] / ($250,000 – $50,000))(1 / 1)} – 1 =
($227,500 / $200,000)1 – 1 = (1.1375)1 – 1.00 = 1.1375 – 1.00 = 0.1375 or 13.75%.
ANSWER (3): For alternative “c,” we can use the following general formula: APR =
0.14($250,000) = $35,000; B = the decrease in the amount of the loan because of paying interest
at the beginning of the year = 0.14($250,000) = $35,000; and, f = fraction of a year the loan is
outstanding = 1 year. Inserting our values for rP, P, B, and f into our equation, we have: APR =
[rP / (P – B)](1 / f) = [$35,000 / ($250,000 – $35,000)](1 / 1) = [$35,000 / $215,000](1) =
[0.1375](1) = 0.1627907 or about 16.28%. [NOTE. The interest paid at the beginning of the year
= 0.14($250,000) = $35,000. This serves to lower the cash advance by $35,000. In essence, it
functions like a compensating balance.]
With an annual loan, once again we have f is 1. Thus, the APY will be the same as the APR. We
will go ahead and show this. We use the following formula: APY =
values, we have APY = {([($250,000 – $35,000) + $35,000] / ($250,000 – $35,000))(1 / 1)} – 1 =
($250,000 / $215,000)1 – 1 = (1.1627907)1 – 1 = 1.1627907 – 1 = 0.1627907 or 16.28%.
ANSWER (4): Ray will choose the alternative “b.” He chooses this alternative because it is the
cheapest. The effective annual rate is only 13.75% for this alternative compared with 15.00% for
alternative “a” and 16.28% for alternative “c.”
73. Show that for any working capital problem the APR and the APY will be the same when
the period is a year.
We will show the APR and APY are equal when the period is a year by showing that the equation
for APR and the equation for APY each equal [rP / (P – B)] when the period is a year.
For APR, we have: APR = [rP / (P – B)](1 / f). Note that when the period is a year that f = 1.
Inserting 1 for f in our APR equation, we have: APR = [rP / (P – B)](1 / 1) = [rP / (P – B)].
For APY, we have: APY = {(1 + [rP / (P – B)])(1 / f)} – 1. Once again, we can note that when the
period is a year that f = 1. Inserting 1 for f in our APY equation, we have: APY =
{(1 + [rP / (P – B)])(1 / 1)} – 1 = {(1 + [rP / (P – B)])1} – 1 = (1 + [rP / (P – B)]) – 1 =
1 + [rP / (P – B)] – 1 = [rP / (P – B)].
SIDEBAR: The APR and APY are the same because the component 1(1 / f) = 1(1 / f) when f = 1.
Inserting f = 1 in each expression, we have: 1(1 / f) = 1(1 / 1) = 1 and 1(1 / f) = 1(1 / 1) = 1(1 / 1) = 1(1)
= 1.
74. Fox, Inc. needs $12M (M = million) in cash next year. It believes it can earn 12% per
year on funds invested in marketable securities and converting marketable securities to cash costs
$312.50 per transaction. Fox’s goals are: have a weekly deposit not exceeding $260,000 per
week, have an average cash balance of at least $120,000, have transaction and opportunity costs
not exceeding $16,000, and have total costs not exceeding $32,000. Fox will use the Baumol cash
management model Answer the below questions.
(1) What is the decision variable for the Baumol cash management model? What is the
effect when this decision variable increases?
(2) Describe the formula that Fox can use to compute its optimal deposit size. This
decision variable is a function of what? The optimal deposit size provides for what?
(3) What is Fox’s optimal deposit size?
(4) Describe the formula that Fox can use to compute the cost of meeting its transactions
demand?
(5) What is Fox’s annual cost of meeting its transactions demand? Describe the subparts
of your solution.
(6) Did Fox achieve its goals?
ANSWER (1): The decision variable is C, the deposit size. Increasing C increases the average
cash balance and the opportunity cost as well. However, increasing C reduces the number of
deposits, thereby lowering the annual transactions cost.
ANSWER (2): The optimal deposit size is: C* = (2bT / i)0.5. The optimal deposit size is a
function of the transactions cost b, the annual transactions volume T, and the annual interest rate
i. C* is positively related to b and T and negatively related to i. Note that the optimal deposit size
is not linearly related to these variables. For example, if T doubles, then the optimal deposit size
will also increase––but it won’t double. The best or optimal deposit size, C*, provides the
minimum total cost, Cost*.
ANSWER (3): Using C* = [2(b)T / i]0.5, Fox’s optimal deposit size is: C* = [2(b)T / i]0.5 =
[2($312.50)$12M / 0.12]0.5 = [$7,500M / 0.12]0.5 = [$62,500M]0.5 = $250,000.
ANSWER (4): The annual cost of meeting its transactions demand is the transactions cost plus
the opportunity (time value) cost. We have: Cost = b(T / C) + i(C / 2) where T = annual
transactions volume in dollars (uniform through time), b = fixed cost per transaction,
i = annual interest rate, C = size of each deposit.
ANSWER (5): Now, we use the annual cost equation. We have: Cost = b(T / C) + i(C / 2) =
$312.50($12M / $0.25M) + 0.12($0.25M / 2) = $15,000 + $15,000 = $30,000. The subparts of the
solution are: T/C = 48 deposits per year; b[T / C] = $312.50(48) = $15,000 transactions costs per
year; C/2 = $125,000 average cash balance; i(C / 2) = 0.12($125,000) = $15,000 annual
opportunity cost of funds.
ANSWER (6): Fox can meet its goals which are: have a weekly deposit not exceeding $260,000
per week, have an average cash balance of at least $120,000, have transaction and opportunity
costs not exceeding $16,000, and have total annual costs not exceeding $32,000. It would make
about one deposit per week of $250,000. The average cash balance is $125,000. Transactions
costs are $15,000, opportunity costs are $15,000, and the total annual cost is $30,000.
75. Suppose ABC, Inc. has estimated the standard deviation of its daily cash flows (outflows
minus inflows for the day) to be σ = $50,000 per day. In addition, the transaction cost of buying
or selling marketable securities is $100. The APR interest rate is 10%. Because of its liquidity
requirements and compensating balance agreements, ABC has a lower control limit (LCL) of
$100,000 on its cash balances. Answer the below questions.
(1) What would be ABC’s upper control limit and return point, using the Miller-Orr
model?
(2) What is the upper control limit (UCL)
(3) What is the return point (RP)?
(4) What will ABC do if the cash balance falls to $100,000?
(5) What will ABC do if the cash balance climbs to $364,375?
(6) What will be ABC’s average cash balance?
ANSWER (1): First, we find Z which is the amount above the return point. We have: Z =
[3(b)(σ)2 / 4(i)]1/3 where b is the cost per transaction of buying or selling marketable securities, σ
is the standard deviation of its net daily cash flow, i is the APR divided by 365. Inserting our
values, we have: Z = [3(b)(σ)2 / 4(i)]1/3 = [3($100)($50,000)2 / 4(0.1 / 365)]1/3 = [3($100)
($2,500M) / 4(0.1 / 365)]1/3 = [$750,000M / 0.00010958904]1/3 = [$6.84375(10)14]0.33333 =
$88,124.68 or about $88,125.
ANSWER (2): The upper control limit is: UCL = LCL + 3Z = $100,000 + 3($88,125) =
$364,375.
ANSWER (3): The return point is: RP = LCL + Z = $100,000 + $88,125 = $188,125.
ANSWER (4): If the cash balance falls to $100,000, ABC sells Z = $88,125 of securities and
puts the cash in the cash account, thereby bringing the balance up to the return point of $188,125.
ANSWER (5): If the cash balance climbs to $364,375, ABC buys 2Z = $176,250 of securities
from cash, thereby reducing the cash balance to the return point of $364,375 – $176,250 =
$188,125.
ANSWER (6): ABC’s average cash balance (ACB) will be: ACB = LCL + (4/3)Z =
100,000 + (4/3)(88,125) = $217,500.
V. Short Answers
76. What is working capital management?
It is the management of current assets and current liabilities.
77. What is the cash conversion cycle?
It is the length of time between the payment of a firm's accounts payable and the receipt of cash
from its accounts receivable.
78. What does the transactions demand for money refer to?
It refers to the need for cash to accommodate a firm's expected cash transactions.
79. What does the precautionary demand for money refer to?
It refers to the need for cash to meet unexpected or extraordinary contingencies with a buffer
stock of cash.
80. What does the speculative demand for money refer to?
It refers to the need for cash to take advantage of investment opportunities that may arise.
81. What are compensating balances?
They are excess balances that are left at a bank to provide indirect compensation for loans
extended or other bank services.
82. What does float refer to?
It refers to the difference between the firm's available or collected balance at its bank and the
firm's book (or ledger) balance.
83. What does disbursement float refer to?
It refers to the positive float that is created between the time that a check is written and it is
finally cleared out of the checking account.
84. What does collection float refer to?
It refers to the negative float that is created between the time that you deposit a check in your
account and when the funds from the check are made available.
85. What does trade credit refer to?
It refers to credit extended by one business to another to facilitate the sale of its goods and
services.
86. What does line of credit refer to?
It refers to an informal arrangement between a bank and a customer establishing a maximum loan
balance that the bank will permit the borrower.
87. What does revolving credit agreement refer to?
It refers to a legal commitment where a bank promises to lend a customer up to a specified

maximum amount during a specified period.
88. What is a transaction loan?
It is a loan extended by a bank for a specific purpose. In contrast, lines of credit and revolving
credit agreements involve loans that can be used for various purposes.
89. What is a term loan?
It is an intermediate term loan (1-10 years) for a specified amount. Term loans are usually repaid
according to a specified schedule.
90. What is a prime rate?

It is the benchmark interest rate that banks charge large, creditworthy corporations.
91. What is a discount loan?
It is a loan which requires the borrower to pay the interest in advance.
92. What is commercial paper?
It is short-term, unsecured promissory notes sold by large businesses that have a maturity of up to
270 days.
93. What is an electronic data interchange (EDI)?
It is the exchange of information electronically, directly from one business's computer to

another's, in a structured format.
94. What is a checking account?
It is a place to “collect” money between inflows and outflows.
95. What does the goal of working capital management seek?
It seeks shareholder wealth maximization, avoiding negative and seeking positive NPV decisions.
VI. Essays or Longer Answers
96. Name and describe the four basic business relationships included in working capital
management.
First, there is the relationship with sales. Working capital management can boost sales and fill
orders quickly when it grants easy credit and keeps high inventories (thereby causing an
immediate sales impact but raising costs). Second, there is the interrelatedness with liquidity. A
firm must choose its levels of cash and marketable securities while allowing for liquidity and any
required compensating balances. Third, there is the relationship with stakeholders. For example,
suppliers and customers are intimately affected by the management of working capital. Finally,
there is the association with short-term financing mix. A firm must choose its mix of types of
short-term financing, and its proportions of short- and long-term financing.
97. Name and describe the three approaches that characterize a firm’s philosophy about how
it finances working capital. Which approach is considered the base-case scenario? When should a
firm be more conservative? When should a firm be more aggressive?
We can characterize a firm's philosophy about how it finances working capital as the maturity-
matching approach, the conservative approach, or the aggressive approach. In the maturity-
matching approach, the firm hedges its risk by matching the maturities of its assets and liabilities.
The conservative approach uses more long-term and less short-term financing than the maturity-
matching approach. An aggressive approach relies more upon short-term financing. While there
is greater risk relying upon short-term financing to be renewed at the same rate, short-term
financing is typically cheaper leading to higher profits.
We can think of the maturity-matching approach as the base-case scenario. If interest rates rise
unexpectedly, a firm using the aggressive approach loses relative to less aggressive (maturity-
matching and conservative) firms. This is because firms with more long-term financing locked in
at the lower rate will have lower financing costs. But if interest rates fall, the situation is reversed
and the aggressive firm is a winner. This is because firms with more long-term financing may be
stuck with either higher interest costs or the cost of refinancing. Because of the possibility that
funds might become more expensive or even unavailable, a firm without ready access to capital
markets should be more conservative. The availability of financing at a fixed cost can be ensured
by locking in long-term financing. In contrast, a firm with ready capital market access can be
more aggressive and worry less about locking in long-term rates.
98. Name and describe the three basic motives for holding cash: transactions demand, the
precautionary demand, and the speculative demand. How can a firm go about to help meet the
three basic demands for cash.
First, the transactions demand is simply the need for cash to make everyday payments for such
things as wages, raw materials, taxes, and interest. Second, the precautionary demand is
essentially the margin of safety required to meet unexpected needs. Third, the speculative demand
is based on the desire to take advantage of unexpected profitable opportunities that require cash
(e.g., getting a discount by buying large quantities of raw materials).
To help meet the three basic demands for cash, firms can hold cash in compensating balances. A
compensating balance is an account balance that the firm agrees to maintain. It provides indirect
payment to the bank for its loans or other services. Commercial banks may accept or require
compensating balances instead of direct fees. The balance provides the bank with money for
which it does not have to pay interest.
99. Discuss the Baumol cash management model. Give the Baumol formulas for the annual
cost of meeting the transactions demand and for the optimal deposit size. Describe each.
The Baumol cash management model assumes the firm can predict its future cash requirements
with certainty, cash disbursements are spread uniformly over the period, the interest rate (the
opportunity cost of holding cash) is fixed, and the firm pays a fixed transactions cost each time it
converts securities to cash. The Baumol model has a sawtooth pattern of cash balances. The firm
sells C dollars worth of marketable securities and deposits the funds in its checking account. The
cash balance decreases steadily to zero as the cash is spent. Then the firm sells C dollars of
marketable securities and deposits the funds in the checking account, and the pattern repeats
itself. Over time, the average (mean) cash balance will be C/2. The time value (opportunity cost)
of funds is the interest rate i, times the average balance, i(C / 2). Likewise, if each deposit is for C
dollars and the firm needs to deposit a total of T dollars in its account during the year, the total
number of deposits is equal to T/C. The annual transactions cost will be cost per deposit times the
number of deposits, which is b(T / C).
The annual cost of meeting the transactions demand is the transactions cost plus the opportunity
(time value) cost. We have: Cost = b(T / C) + i(C / 2) where T = annual transactions volume in
dollars (uniform through time), b = fixed cost per transaction, i = annual interest rate, C = size of
each deposit. The decision variable is C, the deposit size. Increasing C increases the average cash
balance and the opportunity cost as well. However, increasing C reduces the number of deposits,
thereby lowering the annual transactions cost. The best or optimal deposit size C*, provides the
minimum total cost, Cost*. The optimal deposit size is: C* = [2(b)T / i]0.5. The optimal deposit
size is a function of the transactions cost b, the annual transactions volume T, and the annual
interest rate i. C* is positively related to b and T and negatively related to i.
100. Describe the devices and procedures used by firms to manage float.
Large payments can be made with wire transfers instead of paper checks. This reduces the
(disbursement) float and is more costly for the firm to pay this way. Zero balance accounts
(ZBAs) are special disbursement accounts that have a zero balance. They are funded out of a
master account. Funds are automatically transferred into the ZBAs when checks are presented on
them. Controlled disbursing is a technique that uses disbursing accounts at several banks in
addition to the master account at the firm's lead bank. They work like ZBAs. By centralizing
payables, a cash manager knows when all bills must be paid and can make sure that funds are
available and bills are paid on time. Lockboxes are post office boxes to which a firm directs its
incoming checks. A bank is engaged to open the lockbox several times per day, process the
checks, and collect them. This speed up the collection process (and shortens the collection float).

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CH 10 - Working Capital Management

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Test Bank Chapter 22: WORKING CAPITAL MANAGEMENT EFS

I. True or False (Definitions and Concepts)

F 1. Working capital management includes several basic business relationships

T 2. Working capital management consists of managing a firm's current assets and

F 6. A transaction balance is an account balance that the firm agrees to maintain.

F 7. The precautionary demand is based on the desire to take advantage of unexpected

T 9. Cash and marketable securities are managed together.

b 16. The Baumol cash management model assumes .

b 17. The Miller-Orr cash management model .

a 19. Main sources of short-term funds include .

b 20. Bank term loans represent .

a 21. Electronic data interchange (EDI) allows the exchange of information

c 26. says to periodically evaluate routine capital market alternatives to

c 27. is based on the desire to take advantage of unexpected profitable

a 28. is essentially the margin of safety required to meet unexpected needs.

d 29. The transactions demand .

d 30. Which of the following statements is false?

a 31. Which of the following statements is false?

d 32. Which of the following statements is false?

c 33. is the difference between the available or collected balance at the

a 36. Which of the following statements is true?

b 38. Which of the following statements is false?

b 39. Which of the following statements is true?

a 40. Which of the below statements is false?

c 41. Which of the below statements is false?

d 42. The Capital Market Efficiency Principle says .

c 44. says to use common industry practices as a starting place for

III. Multiple Choice (Problems)

b 62. General Motors Acceptance Corporation (GMAC) issues $50M (M = million) of

IV. Longer Problems

76. What is working capital management?

It is the management of current assets and current liabilities.

77. What is the cash conversion cycle?

81. What are compensating balances?

82. What does float refer to?

83. What does disbursement float refer to?

84. What does collection float refer to?

85. What does trade credit refer to?

86. What does line of credit refer to?

87. What does revolving credit agreement refer to?

It refers to a legal commitment where a bank promises to lend a customer up to a specified

88. What is a transaction loan?

89. What is a term loan?

90. What is a prime rate?

91. What is a discount loan?

It is a loan which requires the borrower to pay the interest in advance.

92. What is commercial paper?

93. What is an electronic data interchange (EDI)?

It is the exchange of information electronically, directly from one business's computer to

94. What is a checking account?

It is a place to “collect” money between inflows and outflows.

95. What does the goal of working capital management seek?

VI. Essays or Longer Answers

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