Working Capital Management quiz Corporate Finance Quiz On May 13, 2024 Share /10 12345678910 Working Capital Management 10 questions in 10 minutes Answers at the end of the exam Pass Score 70% enter full-screen mode by pressing the icon located in the top- right comer of the exam 1 / 10 A company has arranged a $20 million line of credit with a bank, allowing the company the flexibility to borrow and repay any amount of funds as long as the balance does not exceed the line of credit. These arrangements are called : convertibles factoring revolvers A revolver is a short-term borrowing facility in which a bank allows the firm to borrow and repay loans during the life of the line of credit . 2 / 10 Which is most likely considered a secondary source of liquidity ? Centralized cash management system Liquidating long-term assets Trade credit Liquidating long-term assets is a secondary source of liquidity. (Centralized cash management system) is incorrect. Centralized cash management system is considered as a primary source of liquidity. (Trade credit) is incorrect. Trade credit (part of short-term funds) is considered as a primary source of liquidity. 3 / 10 Kwam Solutions must raise €120 million. Kwam has two primary sources of liquidity: €60 million of marketable securities (which can be sold with minimal liquidation/brokerage costs) and €30 million of bonds (which can be sold with 3% liquidation costs). Kwam can sell some or all of either of these portfolios. Kwam has a secondary source of liquidity, which would be to sell a large piece of real estate valued at €70 million (which would incur 10% liquidation costs). If Kwam sells the real estate, it must be sold entirely. (A fractional sale is not possible.) What is the lowest cost strategy for raising the needed €120 million ? Sell €60 million of the marketable securities, €30 million of the bonds, and €34.3 million of the real estate property Sell the real estate property and €57 million of the marketable securities Sell the real estate property and €50 million of the marketable securities Kwam must sell the entire real estate property because the two primary sources (marketable securities and bonds) will not raise the needed €120 million. (Sell €60 million of the marketable securities, €30 million of the bonds, and €34.3 million of the real estate property) is incorrect because it assumes a fractional real estate sale. The real estate sale will raise a net of €63 million (€70 million minus 10% liquidation expenses). To raise the rest of the funds needed (€120 million – €63 million = €57 million), Kwam can sell €57 million of marketable securities, which have minimal liquidation/brokerage costs. 4 / 10 Two analysts are discussing the costs of external financing sources. The first states that the company’s bonds have a known interest rate but that the interest rate on accounts payable and the interest rate on equity financing are not specified. They are implicitly zero. Upon hearing this, the second analyst advocates financing the firm with greater amounts of accounts payable and common shareholders equity. Is the second analyst correct in his analysis ? He is correct in his analysis of accounts payable only He is correct in his analysis of common equity financing only He is not correct in his analysis of either accounts payable or equity financing Although accounts payable do not charge an explicit interest rate, the cost of accounts payable is reflected in the costs of the services or products purchased and in the costs of any discounts not taken. Accounts payable can have a very high implicit cost. Similarly, equity financing is not free. A required return is expected on shareholder financing just as on any other form of financing . 5 / 10 A company increasing its credit terms for customers from 1/10, net 30 to 1/10, net 60 will most likely experience : an increase in the average collection period an increase in cash on hand a lower level of uncollectible accounts A longer average collection period will certainly occur. Higher cash balances and a lower level of uncollectible accounts will not occur . 6 / 10 The SOA Company needs to raise 75 million, in local currency, for substantial new investments next year. Specific details, all in local currency, are as follows : Investments of 10 million in receivables and 15 million in inventory will be made. Fixed capital investments of 50 million, including 10 million to replace depreciated equipment and 40 million of net new investments, will also be made . Net income is expected to be 30 million, and dividend payments will be 12 million. Depreciation charges will be 10 million . Short-term financing from accounts payable of 6 million is expected. The firm will use receivables as collateral for an 8 million loan. The firm will also issue a 14 million short-term note to a commercial bank . Any additional external financing needed can be raised from an increase in long-term bonds. If additional financing is not needed, any excess funds will be used to repurchase common shares. What additional financing does SOA require ? SOA can repurchase 2 million of common shares SOA will need to issue 19 million of bonds SOA will need to issue 26 million of bonds SOA must issue 19 million of bonds Amount (local, millions) Source 6 Accounts payable 8 Bank loan against receivables 14 Short-term note 28 Net income + depreciation – dividends 56 Total sources The firm requires 75 million of financing in local currency terms. Given that the planned sources (before bond financing or repurchases) total 56 million, SOA will need to issue 19 million of new bonds (75-56=19). 7 / 10 Which of the following are considered internal sources of financing for a company’s working capital management ? Accounts payable and accruals Committed and uncommitted lines of credit Accounts receivable and inventory Accounts payable and accruals are internal and a source of cash as they are payments not yet made to suppliers, employees, or other related parties. Lines of credit are external sources of financing. Accounts receivable and inventory are internal uses of cash since a company must access financing to purchase inventory and lend to its customers . 8 / 10 Which of the following is most likely a secondary source of liquidity ? Bank line of credit Trade credit Inventory liquidation Liquidating inventory is a secondary source of liquidity. Trade credit and a bank line of credit are considered primary sources of liquidity. (Bank line of credit ) is incorrect because it is a primary source of liquidity. (Trade credit ) is incorrect because it is a primary source of liquidity 9 / 10 Paloma Villarreal has received three suggestions from her staff about how to address her firm’s liquidity problems. Suggestion 1 ⇒ Reduce the firm’s inventory turnover rate. Suggestion 2 ⇒ Reduce the average collection period on accounts receivable. Suggestion 3 ⇒ Accelerate the payments on accounts payable by paying invoices before their due dates. Which suggestion should Villarreal employ to improve the firm’s liquidity position? Suggestion 1 Suggestion 3 Suggestion 2 Reducing the average collection period would speed up receipts and improve the firm’s liquidity position. The other two suggestions would worsen the firm’s liquidity position. 10 / 10 An analyst is examining the cash conversion cycles and their components for three companies that she covers in the leisure products industry. She believes that changes in the investments in these working capital accounts can reveal liquidity stresses on a company. 2016 2017 2018 2019 2020 2021 Company H 59.8 59.8 57.8 60 70.5 68.4 Days of inventory on hand 93.3 94.7 92.4 95.6 103.4 101.8 + Days of receivables 35.9 36.8 41.9 48 54.6 52.1 – Days of payables outstanding 117.2 117.7 108.3 107.6 119.3 118.1 = Cash conversion cycle Company J 101.4 103.2 105.2 96.3 101.4 105.6 Days of inventory on hand 38 37.8 36.3 32.9 29.4 27.7 + Days of receivables 40.2 37.8 39.3 35.3 38.5 36.6 – Days of payables outstanding 99.2 103.2 102.2 93.9 92.3 96.7 = Cash conversion cycle Company S 81.7 63.4 69.2 118.9 131 135.8 Days of inventory on hand 38.3 29.1 36.2 54.2 42.5 49.1 + Days of receivables 35.9 31.8 29.8 34.6 27.9 30.9 – Days of payables outstanding 84.1 60.7 75.6 138.5 145.6 154.0 = Cash conversion cycle Which company’s operating cycle appears to have caused the most liquidity stress ? Company H’s Company J’s Company S’s Company S’s cash conversion cycle nearly doubled over recent years, while the cash conversion cycles for Companies H and J are nearly unchanged. The days of inventory on hand and days of receivables both increased substantially for Company S, and its days of payables outstanding decreased very slightly. The net effect was the large increase in the cash conversion cycle. Although changes occurred in the components of the cash conversion cycles for Companies H and J, the net effect on their cash conversion cycles was small. Your score is LinkedIn Facebook Twitter VKontakte Send feedback primary sources of liquidity Secondary sources of liquidity Drags on liquidity and Pulls on liquidity Compare a company’s liquidity position with that of peers Compare a company’s liquidity position with that of peerscomponents of working capital managementdefine working capital management