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Capital management - operating versus financial leverage

Firms with a high degree of operating leverage are
A. easily capable of surviving large changes in sales volume
B. usually trading off lower levels of risk for higher profits.
C. significantly affected by changes in interest rates.
D. trading off higher fixed costs for lower per-unit variable costs.

Which of the following is not a condition under which a prudent manager would accept some risk in financing?
A. Predictable cash-flow patterns
B. Inventory is highly perishable
C. Price of inventory is stable
D. Easy access to capital markets

Agency theory deals with the issue of
A. when to hire an agent to represent the firm in negotiations.
B. the legal liabilities of a firm if an employee, acting as the firm's agent, injures someone.
C. the limitations placed on an employee acting as the firm's agent to obligate or bind the firm.
D. the conflicts that can arise between the viewpoints and motivations of a firm's owners and managers.

In the percent-of-sales method, an increase in dividends
A. will increase required new funds.
B. will decrease required new funds.
C. has no effect on required new funds.
D. more information is needed.

As the dividend payout ratio declines more external funds are required.
True or False

Cash flow consists of illiquid cash equivalents which are difficult to convert to cash within 90 days.
True or False

The income statement measures the increase in the assets of a firm over a period of time.
True or False

Profitability ratios allow one to measure the ability of the firm to earn an adequate return on sales, total assets, and invested capital.
True or False

Computerized cash management and electronic funds transfer allow firms to carry smaller cash balances.
True or False

Stretching the payment period refers to the practice of trying to take a trade discount after the discount period.
True or False

The following is the balance sheet for 2003 for Marbell Inc.

Sales for 2002 were $300,000. Sales for 2003 have been projected to increase by 20%. Assuming that Marbell Inc. is operating below capacity, calculate the amount of new funds required to finance this growth. Marbell has an 8% return on sales and 70% is paid out as dividends.

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Study Questions
Firms with a high degree of operating leverage are
A. easily capable of surviving large changes in sales volume
B. usually trading off lower levels of risk for higher profits.
C. significantly affected by changes in interest rates.
D. trading off higher fixed costs for lower per-unit variable costs.
Answer: D. trading off higher fixed costs for lower per-unit variable costs

Cash flow consists of illiquid cash equivalents which are difficult to convert to cash within 90 days.
Answer: False

The income statement measures the increase in the assets of a firm over a period of time.
Answer: False
Reason: The income statement measures performance over a specific period of time, say, a year.The accounting definition of income is Revenue - Expenses = Income
...

Solution Summary

This post addresses the conceptual questions related to working capital management. There are 4 MCQs, 6 T/F and one problem which are answered so that the students can have better clarity of the concepts involved with working capital management..

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