Working Capital Management Quiz

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Working Capital

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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 ?

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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 ?

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Selected liquidity ratios for three firms in the leisure products industry are given in the table below. The most recent fiscal year ratio is shown along with the average of the previous five years.

Company S Company J Company H
Five-year average Most recent Five-year average Most recent Five-year average Most recent
2.53 3.05 3.04 3.67 2.51 5.37 Current ratio
1.44 1.78 2.01 2.6 2.19 5.01 Quick ratio
0.67 0.96 1.28 1.96 0.97 3.66 Cash ratio

Relative to its peers and relative to its own prior performance, which company is in the most liquid position ?

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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?

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Which of the following are considered internal sources of financing for a company’s working capital management ?

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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 ?

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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 ?

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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 ?

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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 :

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A company increasing its credit terms for customers from 1/10, net 30 to 1/10, net 60 will most likely experience :

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Which of the following is most likely a secondary source of liquidity ?

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Which is most likely considered a secondary source of liquidity ?

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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 :

 

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

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