Working Capital Liquidity quiz Corporate Finance QuizFinancial Analysis Quiz Share Working Capital Liquidity 10 questions in 10 minutes Pass Score 70% 1 / 10 Which is most likely considered a secondary source of liquidity ? Trade credit Liquidating long-term assets Centralized cash management system 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. 2 / 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 2 Suggestion 3 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. 3 / 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 will need to issue 26 million of bonds SOA can repurchase 2 million of common shares SOA will need to issue 19 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). 4 / 10 XY1 Corporation’s CFO has decided to pursue a moderate approach to funding the firm’s working capital. Which of the following methods would best fit that particular approach ? Finance permanent and variable current assets with short-term financing Finance permanent and variable current assets with long-term financing Finance permanent current assets with long-term financing and variable current assets with short-term financing In a moderate approach, XY1 would attempt to match the duration of the assets with the liabilities. This would allow the company to use long-term financing for permanent working capital needs while at the same time looking to minimize interest expense through the use of more flexible short-term financing on an as-needed basis. 5 / 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 not correct in his analysis of either accounts payable or equity financing He is correct in his analysis of accounts payable only He is correct in his analysis of common equity financing only 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 . 6 / 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 : revolvers factoring convertibles 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 . 7 / 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 a lower level of uncollectible accounts an increase in cash on hand A longer average collection period will certainly occur. Higher cash balances and a lower level of uncollectible accounts will not occur . 8 / 10 Data for a firm are presented in the following table : thousands As of 31 December 200 Cash 350 Accounts receivable 1,250 Inventory 300 Accounts payable 200 Taxes payable 600 Installment loan payable, due in three equal annual payments on 30 June The current ratio for the firm’s industry is 3.2. Based on the current ratio, the firm’s liquidity compared with the industry is best described as being : equivalent higher lower he higher the current ratio, the more liquid the company. Thus, with a current ratio of 2.6 (1,800/700), the company is less liquid than the industry, which has a current ratio of 3.2. Current ratio = Current assets/Current liabilities. thousands Current Liabilities thousands Current Assets 300 Accounts payable 200 Cash 200 Taxes payable 350 Accounts receivable 200 Loan payable, first installment 1,250 Inventory 700 Total 1,800 Total (higher) is incorrect. Failing to include the taxes payable or the loan (or the A/P) gives 1,800/400 = 4.5, which is above the industry average. (equivalent) is incorrect. The firm’s current ratio is 2.6, which is below the industry average. 9 / 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 S’s Company H’s Company J’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. 10 / 10 Which of the following is most likely a secondary source of liquidity ? Inventory liquidation Trade credit Bank line of credit 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 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
