Working Capital Management quiz Managerial Accounting Quiz Share Working Capital Management 10 questions in 15 minutes Pass Score 70% 1 / 10 A company has current assets of $400,000 and current liabilities of $300,000. The company could increase its net working capital by the Purchase of $50,000 of trading securities for cash Prepayment of $50,000 of next year’s rent Refinancing of $50,000 of short-term debt with long-term debt Acquisition of land valued at $50,000 through the issuance of common stock Net working capital is defined as the excess of current assets over currentliabilities. Refinancing short-term debt with long-term debt decreasescurrent liabilities with no effect on current assets, resulting in an increase inworking capital 2 / 10 A corporation is considering a plant expansion that will increase its sales and net income. The following data represent management’s estimate of the impact the proposal will have on the company: Current Proposed Cash $ 120,000 $ 140,000 Accounts payable 360,000 450,000 Accounts receivable 400,000 550,000 Inventory 360,000 420,000 Marketable securities 180,000 180,000 Mortgage payable (current) 160,000 310,000 Fixed assets 2,300,000 3,200,000 Net income 400,000 550,000 The effect of the plant expansion on net working capital will be a(n) Decrease of $10,000 Increase of $10,000 Increase of $240,000 Increase of $230,000 Net working capital is defined as current assets minus current liabilities. Net working capital is calculated as follows: Current Proposed Cash $120,000 $140,000 Accounts receivable 400,000 550,000 Inventory 360,000 420,000 Marketable securities 180,000 180,000 Total current assets $1,060,000 $1,290,000 Accounts payable $360,000 $450,000 Mortgage payable -- current 160,000 310,000 Total current liabilities $ (520,000 ) $ (760,000 ) Working capital $ 540,000 $ 530,000 Net working capital decreases by $10,000 from the current $ 540,000 to $ 530,000under the proposal. 3 / 10 Which one of the following would increase the net working capital of a firm? Refinancing a short-term note payable with a 2 year note payable Purchase of a new plant financed by a 20 year mortgage Cash payment of payroll taxes payable Cash collection of accounts receivable 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. 4 / 10 Determining the appropriate level of working capital for a firm requires : Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency Maintaining short-term debt at the lowest possible level because it is generally more expensive than long-term debt Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total investments Changing the capital structure and dividend policy of the firm Working capital finance concerns the determination of the optimal level, mix, and use of current assets and current liabilities. The objective is to minimize the cost of maintaining liquidity while guarding against the possibility of technical insolvency. Technical insolvency is defined as the inability to pay debts as they come due 5 / 10 Of the following, the working capital financing policy that would subject a firm to the greatest level of risk is the one where the firm finances Fluctuating current assets with long-term debt Permanent current assets with short-term debt Permanent current assets with long-term debt Fluctuating current assets with short-term debt The maturity matching (self liquidating) approach to financing of currentassets minimizes the risk that the entity cannot pay its debts when theybecome due. It is based on the assumption that the firm can control whenthe assets are liquidated. Accordingly, the riskiest approach is to financepermanent assets with short-term debt. Moreover, short-term financingsubjects the firm to greater risks of interest rate increases and loan renewalproblems. 6 / 10 As a company becomes more conservative with respect to working capital policy, it would tend to have a(n) Increase in the ratio of current assets to noncurrent assets Decrease in the quick ratio Decrease in the operating cycle Increase in the ratio of current liabilities to noncurrent liabilities A conservative working capital policy results in an increase in workingcapital (current assets – current liabilities). It is typified by a reduction inliquidity risk. Increasing the current ratio, whether by decreasing currentliabilities or increasing current assets, minimizes the risk that the companywill not be able to meet its obligations as they fall due. Thus, an increasingratio of current to noncurrent assets means that a company is forgoing thepotentially higher returns on long-term assets in order to guard againstshort-term cash flow problems. 7 / 10 A company is experiencing a sharp increase in sales activity and a steady increase in production, somanagement has adopted an aggressive working capital policy. Therefore, the company’s currentlevel of net working capital Would most likely be lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment Would most likely be higher than under other business conditions as the company’s profits are increasing Would most likely be the same as in any other type of business condition as business cycles tend to balance out over time Would most likely be higher than under other business conditions so that there will be sufficient funds to replenish assets When a firm has an aggressive working capital policy, management keepsthe investment in working capital at a minimum. Thus, a growing companywould want to invest its funds in capital goods and not in idle assets. Thispolicy maximizes return on investment at the price of the risk of minimalliquidity. 8 / 10 board of directors has determined 4 options to increase working capital next year. Option 1 is to increase current assets by $120 and decrease current liabilities by $50. Option 2 is to increase current assets by $180 and increase current liabilities by $30. Option 3is to decrease current assets by $140 and increase current liabilities by $20. Option 4 is todecrease current assets by $100 and decrease current liabilities by $75. Which option should board of directorschoose to maximize net working capital? Option 2 Option 1 Option 3 Option 4 Option 1 is correct. Net working capital is the excess of current assets over current liabilities. An increase in current assets or a decrease in current liabilities will increase net working capital. Option 1 maximizes net working capital, increasing it by $170 ($120 + $50). 9 / 10 If a firm increases its cash balance by issuing additional shares of common stock, net working capital Remains unchanged and the current ratio remains unchanged Increases and the current ratio decreases Increases and the current ratio increases Increases and the current ratio remains unchanged Net working capital is the excess of current assets over current liabilities.The current ratio equals current assets divided by current liabilities. Sellingstock for cash increases current assets and stockholders’ equity, with noeffect on current liabilities. The result is an increase in working capital andthe current ratio. 10 / 10 Determining the appropriate level of working capital for a firm requires : Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance these assets Maintaining short-term debt at the lowest possible level because it is ordinarily more expensive than long-term debt Changing the capital structure and dividend policy for the firm Offsetting the profitability of current assets and current liabilities against the probability of technical insolvency A company must maintain a level of working capital sufficient to pay bills as they come due. Failure to do so is technical insolvency and can result in involuntary bankruptcy. Unfortunately, holding current assets for purposes of paying bills is not profitable for a company because they usually offer a low return compared with longer-term investments. Thus, the skillful management of working capital requires a balancing of a firm’s desire for profit with its need for adequate liquidity Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
