CFA2020L1QbanksAnswers corporate finance

Reading 31:: Introduction to Corporate Governance and Other ESG G Considerations Question #1 of 23 Question ID: 1205670 With a one-tier board structure: A) senior managers determine corporate strategy B) independent directors determine company strategy C) both executives and non-executives can serve on the board of directors Explanation Independent directors and senior managers both serve on a single board with a one-tier board structure and are jointly responsible for determining corporate strategy (Study Session 10, Module 31.1, LOS 31.f) Question #2 of 23 Question ID: 1205668 A ict of interest between corporate stakeholders is least likely to be mitigated by: A) covenants in debt indentures B) including stock options as part of manager compensation C) issuing stock dividends Explanation Issuing stock dividends does not necessarily favor one group of stakeholders over another because neither rm value nor earnings are a ected by issuing a stock dividend Covenants in debt issues protect creditor interests from management actions that would increase the risk of the debt Including stock options as part of manager compensation serves to align the interests of senior management and shareholders (Study Session 10, Module 31.1, LOS 31.e) Question #3 of 23 Question ID: 1205671 A company director's duty of loyalty is most accurately described as requiring a director to: A) act in the interests of the company and its shareholders B) perform his or her duties in good faith and with due diligence C) carry out the duties assigned by the managers of the company Explanation The duty of loyalty requires a company director to act in the interests of the company and its shareholders The duty of care requires a director to act in good faith, with due diligence, and in an informed manner The board of directors is responsible for appointing the company's managers; in companies that not practice CEO duality, the managers not assign duties to board members (Study Session 10, Module 31.1, LOS 31.f) Question #4 of 23 Question ID: 1205664 The relationship between a company's shareholders and its senior managers is best described as a(n): A) principal relationship B) agency relationship C) working partnership Explanation This is an example of an agency relationship, which is also known as a principal-agent relationship A company's senior managers are acting as agents, hired to act in the interest of shareholders who are the principal in the relationship (Study Session 10, Module 31.1, LOS 31.c) Question #5 of 23 Question ID: 1205676 In the absence of any ESG-related constraints speci ed in an investment policy statement, a portfolio manager is most likely to violate duciary duty by using ESG factors to: A) exclude investments with negative ESG characteristics from the investor’s portfolio B) assess the expected return and risk of potential portfolio investments C) choose among investments with similar risk and return characteristics Explanation Constructing a portfolio based on ESG factors may violate duciary duty if doing so reduces expected returns Analyzing ESG factors when assessing investment risk or using ESG factors to choose among otherwise equivalent investments would likely not violate duciary duty (Study Session 10, Module 31.2, LOS 31.j) Question #6 of 23 Risks that may arise from ine ective corporate governance least likely include: A) less e ective decision making B) weaker nancial performance C) reduced default risk Explanation Ine ective corporate governance is likely to increase default risk (Study Session 10, Module 31.2, LOS 31.h) Question ID: 1205674 Question #7 of 23 Question ID: 1205660 The stakeholders of a company that prefer a relatively riskier company strategy that has the potential for superior company performance are: A) shareholders B) creditors C) suppliers Explanation Shareholders have the greatest gains from superior company performance Suppliers may bene t but, in general, have a preference for stable business operations and continuation of their business relationship with the company Creditors prefer less risk because their potential gains from superior company performance are limited while the have signi cant downside risk (Study Session 10, Module 31.1, LOS 31.b) Question #8 of 23 Question ID: 1205659 The interests of community groups a ected by a company's operations are most likely to be considered in corporate governance under: A) special interest theory B) stakeholder theory C) shareholder theory Explanation Community groups may be one of the stakeholder groups considered under stakeholder theory (Study Session 10, Module 31.1, LOS 31.a) Question #9 of 23 Question ID: 1205663 The stakeholder group that typically prefers the greatest amount of business risk is: A) senior managers B) shareholders C) directors Explanation Compared to the other two groups, shareholders have the greatest potential gains from riskier strategies and can diversify their holdings across rms in order to reduce the in uence of company speci c risk While senior managers can gain from company outperformance, they typically prefer less risk than shareholders because managers' risk of poor company performance on the value of their options and on their careers cannot be easily diversi ed away (Study Session 10, Module 31.1, LOS 31.b) Question #10 of 23 Question ID: 1205662 Which of the following stakeholders are most likely to bene t from a company's growth and excellent nancial performance? A) Customers B) Creditors C) Governments Explanation Governments receive greater tax revenues when nancial performance is excellent and pro ts are higher Creditors not receive extra returns for performance better than that is adequate to repay debt Customers seek company stability and ongoing relationships with the company (Study Session 10, Module 31.1, LOS 31.b) Question #11 of 23 Question ID: 1205669 A company's internal systems and practices for managing stakeholder relationships are most accurately described as its: A) organizational infrastructure B) contractual infrastructure C) governance infrastructure Explanation Organizational infrastructure is a company's corporate governance procedures and internal systems and practices for managing stakeholder relationships (Study Session 10, Module 31.1, LOS 31.e) Question #12 of 23 Question ID: 1205666 In the context of stakeholder management, organizational infrastructure is most accurately described as: A) contractual arrangements a company enters into with its stakeholders B) a company’s internal procedures for addressing stakeholder relationships C) a framework for de ning the rights and responsibilities of stakeholders Explanation Organizational infrastructure refers to the practices and governance procedures that a company adopts to manage its stakeholder relationships (Study Session 10, Module 31.1, LOS 31.d) Question #13 of 23 Question ID: 1205661 The stakeholders most likely to be concerned with their legal liabilities are: A) directors B) creditors C) regulators Explanation Directors are legally responsible for their decisions and actions as board members Neither regulators nor creditors face signi cant legal liabilities for their actions (Study Session 10, Module 31.1, LOS 31.b) Question #14 of 23 Question ID: 1205667 Minority shareholder groups are most likely to have in uence over corporate strategy when board elections: A) use cumulative voting B) are staggered C) use majority voting Explanation With cumulative voting, minority shareholders are more likely to gain seats on the board of directors and in uence corporate strategy and decisions than with majority voting Staggered board elections limit the ability of shareholders to select an entirely new board, except over a period of years (Study Session 10, Module 31.1, LOS 31.e) Question #15 of 23 Question ID: 1205658 The stakeholder theory of corporate governance is primarily focused on: A) resolving the competing interests of those who manage companies and other groups a ected by a company’s actions B) increasing the value a company C) the interests of various stakeholders rather than the interests of shareholders Explanation Resolving the icting interests of both shareholders and other stakeholders is the focus of corporate governance under stakeholder theory Shareholders are among the groups whose interests are considered under stakeholder theory (Study Session 10, Module 31.1, LOS 31.a) Question #16 of 23 Question ID: 1205678 Thematic investing is most accurately described as: A) excluding companies or sectors from consideration for investment based on environmental and social factors B) considering a single environmental or social factor when selecting investments C) identifying the best companies in each sector with respect to environmental and social factors Explanation Thematic investing refers to selecting investments with a view to a speci c environmental, social, or governance factor Identifying the best companies in each sector with respect to environmental and social factors is referred to as best-in-class investing Excluding companies or sectors from consideration for investment based on environmental and social factors is referred to as negative screening (Study Session 10, Module 31.2, LOS 31.k) Question #17 of 23 Question ID: 1205679 Which of the following environmental factors is least likely to arise from inadequate internal controls and safety standards? A) Stranded assets B) Waste contamination C) Local resource depletion Explanation In the context of ESG factors, stranded assets refer to carbon resources that become uneconomic because of outside forces such as changes in regulation (Study Session 10, Module 31.2, LOS 31.k) Question #18 of 23 Question ID: 1205677 Environmental, social, and governance (ESG) investing is most accurately described as: A) excluding companies in carbon production based industries from consideration for investment B) integrating environmental and social considerations into the investment decision making process C) investing only in companies that promote environmental or social initiatives favored by an investor Explanation ESG investing is using environmental, social, and governance factors when making investment decisions Investing only in companies that promote environmental or social initiatives favored by an investor is best described as impact investing Excluding companies in carbon production based industries from consideration for investment is best described as negative screening (Study Session 10, Module 31.2, LOS 31.j) Question #19 of 23 Question ID: 1205657 Which of the following statements about corporate governance is most accurate? Corporate governance: A) may be focused only on shareholder interests B) best practices are essentially the same in developed economies C) is de ned in the same way in most countries Explanation Under the shareholder theory of corporate governance, practices are primarily those that support shareholder interests, while under the stakeholder theory of corporate governance, the interests of various a ected groups are considered and balanced Corporate governance practices and de nitions vary across countries (Study Session 10, Module 31.1, LOS 31.a) Question #20 of 23 Question ID: 1205673 Shareholders who use their share voting power or other means to pressure companies to make changes they believe will increase shareholder value are most accurately described as: A) activist shareholders B) ESG shareholders C) proxy shareholders Explanation Activist shareholders seek changes in company operations that they believe will increase shareholder value (Study Session 10, Module 31.2, LOS 31.g) Question #21 of 23 A principal-agent relationship most likely exists between a company's: A) shareholders and managers B) directors and regulators C) customers and suppliers Question ID: 1205665 Explanation The relationship between shareholders and managers is a principal-agent relationship Shareholders, as principals, through the board of directors hire managers, as agents, to act in the best interests of the shareholders (Study Session 10, Module 31.1, LOS 31.c) Question #22 of 23 Question ID: 1205675 To judge whether management's incentives are aligned with a rm's stated goals, an analyst should examine the rm's: A) share class structure B) cross-shareholdings C) remuneration programs Explanation Disclosures of a rm's remuneration programs enable an analyst to judge whether its compensation structure aligns management's incentives with the rm's objectives and shareholders' interests (Study Session 10, Module 31.2, LOS 31.i) Question #23 of 23 Question ID: 1205672 Smith Company's board of directors assigns responsibilities to three committees The committee that is most likely to be responsible for establishing the chief executive o cer's compensation package is Smith's: A) nominations and remuneration committee B) audit and governance committee C) investment and risk committee Explanation Compensation for a company's senior executives is typically a responsibility of a remuneration or compensation committee (Study Session 10, Module 31.1, LOS 31.f) Reading 32:: Capital Budgeting Question #1 of 62 Question ID: 1205730 A rm is evaluating two mutually exclusive projects of the same risk class, Project X and Project Y Both have the same initial cash outlay and both have positive NPVs Which of the following is a su cient reason to choose Project X over Project Y? A) Project X has both a shorter payback period and a shorter discounted payback period compared to Project Y B) Project Y has a lower pro tability index than Project X C) Project Y has a lower internal rate of return than Project X Explanation The correct method of choosing between two mutually exclusive projects is to choose the one with the higher NPV The pro tability index is calculated as the present value of the future cash ows divided by the initial outlay for the project Because both projects have the same initial cash outlay, the one with the higher pro tability index has both higher present value of future cash ows and the higher NPV Ranking projects on their payback periods or their internal rates of return can lead to incorrect ranking (Study Session 10, Module 32.2, LOS 32.e) Question #2 of 62 Question ID: 1205703 Fisher, Inc., is evaluating the bene ts of investing in a new industrial printer The printer will cost $28,000 and increase after-tax cash ows by $7,000 during each of the next four years and $6,000 in each of the two years after that The internal rate of return (IRR) of the printer project is closest to: A) 11.6% B) 11.8% C) 12.0% Explanation IRR Keystrokes: CF0 = -$28,000; CF1 = $7,000; F1 = 4; CF2 = $6,000; F2 = 2; CPT → IRR = 11.6175% (Study Session 10, Module 32.1, LOS 32.d) Question #3 of 62 Question ID: 1205696 A company is considering the purchase of a copier that costs $5,000 Assume a cost of capital of 10 percent and the following cash ow schedule: Year 1: $3,000 Year 2: $2,000 Year 3: $2,000 Determine the project's NPV and IRR NPV IRR A) $883 20% B) $883 15% C) $243 20% Explanation To determine the NPV, enter the following: PV of $3,000 in year = $2,727, PV of $2,000 in year = $1,653, PV of $2,000 in year = $1,503 NPV = ($2,727 + $1,653 + $1,503) − $5,000 = 883 You know the NPV is positive, so the IRR must be greater than 10% You only have two choices, 15% and 20% Pick one and solve the NPV If it is not close to zero, then you guessed wrong; select the other one [3000 ÷ (1 + 0.2)1 + 2000 ÷ (1 + 0.2)2 + 2000 ÷ (1 + 0.2)3] − 5000 = 46 This result is closer to zero (approximation) than the $436 result at 15% Therefore, the approximate IRR is 20% (Study Session 10, Module 32.1, LOS 32.d) Question #4 of 62 Question ID: 1205690 Rosalie Woischke is an executive with ColaCo, a nationally known beverage company Woischke is trying to determine the rm's optimal capital budget First, Woischke is analyzing projects Sparkle and Fizz She has determined that both Sparkle and Fizz are pro table and is planning on having ColaCo accept both projects Woischke is particularly excited about Sparkle because if Sparkle is pro table over the next year, ColaCo will have the opportunity to decide whether or not to invest in a third project, Bubble Which of the following terms best describes the type of projects represented by Sparkle and Fizz as well as the opportunity to invest in Bubble? Sparkle and Fizz Opportunity to invest in Bubble A) Independent projects Project sequencing B) Independent projects Add-on project C) Mutually exclusive projects Explanation Project sequencing A rm has average days of receivables outstanding of 22 compared to an industry average of 29 days An analyst would most likely conclude that the rm: A) has better credit controls than its peer companies B) may have credit policies that are too strict C) has a lower cash conversion cycle than its peer companies Explanation The rm's average days of receivables should be close to the industry average A signi cantly lower average days receivables outstanding, compared to its peers, is an indication that the rm's credit policy may be too strict and that sales are being lost to peers because of this We can not assume that stricter credit controls than the average for the industry are "better." We cannot conclude that credit sales are less, they may be more, but just made on stricter terms The average days of receivables are only one component of the cash conversion cycle (Study Session 11, Module 35.1, LOS 35.b) Question #10 of 44 Question ID: 1205881 Compared to the prior period, a rm has greater days of receivables The e ect on the rm's cash conversion cycle and operating cycle are most likely a(n): Cash conversion cycle Operating cycle A) Decrease Increase B) Increase Decrease C) Increase Increase Explanation Greater days of receivables will increase both the cash conversion cycle and operating cycle, other things equal (Study Session 11, Module 35.1, LOS 35.c) Question #11 of 44 Question ID: 1205877 The quick ratio is considered a more conservative measure of liquidity than the current ratio because the quick ratio excludes: A) inventories, which are not necessarily liquid B) short-term marketable securities, which may need to be sold at a signi cant loss C) accounts receivable, which may not be collectible in the short term Explanation The quick ratio is usually de ned as (current assets – inventory) / current liabilities It is a more restrictive measure of liquidity than the current ratio, which equals current assets / current liabilities The numerator of the quick ratio includes cash, receivables, and short-term marketable securities (Study Session 11, Module 35.1, LOS 35.b) Question #12 of 44 Question ID: 1205901 Randox Industries has the following investment policy statement: "In order to achieve the safety and liquidity necessary in the investment of excess cash balances, the CFO or his designee may invest excess cash balances in 30-day U.S Treasury bills, or in banker's acceptances with maturities of less than 31 days or 30day certi cates of deposit, where the credit rating of the issuing bank is A+ or higher." This policy statement is: A) inappropriate because it is too restrictive B) inappropriate because both banker’s acceptances and certi cates of deposit are illiquid C) appropriate because these are all safe, liquid securities Explanation The policy statement is inappropriate because it is too restrictive A policy statement should focus on meeting the speci c safety and liquidity needs of the rm but should also allow the exibility to increase yield within these constraints There are many other securities potentially suitable for cash management that would provide equivalent or better liquidity and safety of principal at least equivalent to that of the securities issued by A+ rated banks (Study Session 11, Module 35.1, LOS 35.e) Question #13 of 44 Question ID: 1205912 Which of the following forms of short-term nancing is typically used to facilitate international trade? A) Banker’s acceptances B) Overdraft line of credit C) Commercial paper Explanation Banker's acceptances are used by rms that export goods A banker's acceptance is a guarantee from the bank of the rm that has ordered the goods stating that a payment will be made upon receipt of the goods The exporting company can then sell this acceptance at a discount in order to generate immediate funds (Study Session 11, Module 35.1, LOS 35.g) Question #14 of 44 Question ID: 1205880 Compared to the prior year, Chart Industries has reported that its operating cycle has remained relatively stable while its cash conversion cycle has decreased The most likely explanation for this is that the rm: A) has improved its inventory turnover B) is relying more on its suppliers for short-term liquidity C) is paying its bills for raw materials more rapidly Explanation The cash conversion cycle is its operating cycle minus its average days payables outstanding Therefore, the rm's average days payables must have increased, a clear indication that the rm is relying more heavily on credit from its suppliers Improved inventory turnover would tend to decrease both the operating and cash conversion cycles Relaxed credit policies would tend to increase the rm's operating cycle as receivables turnover would tend to decrease (Study Session 11, Module 35.1, LOS 35.c) Question #15 of 44 Question ID: 1205872 Liquidating short-term assets and renegotiating debt agreements are best described as a rm's: A) pulls and drags on liquidity B) secondary sources of liquidity C) primary sources of liquidity Explanation Secondary sources of liquidity include liquidating short-term or long-lived assets, negotiating debt agreements (i.e., renegotiating), or ling for bankruptcy and reorganizing the company Primary sources of liquidity are the sources of cash a company uses in its normal operations Pulls and drags on liquidity refer to factors that weaken a company's liquidity position (Study Session 11, Module 35.1, LOS 35.a) Question #16 of 44 Question ID: 1205879 In a recent sta meeting, David Hurley, stated that analysts should understand that nancial ratios mean little by themselves He advised his colleagues to evaluate nancial ratios carefully During the discussion he made the following statements: Statement 1: A company can be compared with others in its industry by relating its nancial ratios to industry norms However, care must be taken because many ratios are industry-speci c, but not all ratios are important to all industries Statement 2: Comparing a company to the overall economy is useless because overall business conditions are constantly changing Speci cally, it is not the case that nancial ratios tend to improve when the economy is strong and weaken during recessionary times Are statements and as made by Hurley regarding nancial ratio analysis CORRECT? Statement Statement A) Correct Incorrect B) Correct Correct C) Incorrect Correct Explanation Financial ratios are meaningless by themselves To have meaning an analyst must use them with other information An analyst should evaluate nancial ratios based on industry norms and economic conditions Statement is correct However, statement is not because nancial ratios tend to improve when the economy is strong and weaken when the economy is in a recession So, nancial ratios should be reviewed in light of the current stage of the business cycle (Study Session 11, Module 35.1, LOS 35.b) Question #17 of 44 Question ID: 1205890 Which of the following factors is most likely to cause a rm to need short-term nancing? A) Return of principal from maturing investments B) Shorter cash conversion cycle than the industry average C) Operating cash in ows that uctuate seasonally Explanation Firms with operating cash in ows that uctuate seasonally are likely to experience short-term imbalances between cash in ows and cash out ows and must forecast these imbalances to manage their net daily cash positions, for example by arranging short-term borrowing over seasons when operating cash in ows are expected to be relatively low and operating cash out ows are relatively high (Study Session 11, Module 35.1, LOS 35.d) Question #18 of 44 Question ID: 1205878 Which of the following is least likely an indicator of a rm's liquidity? A) Inventory turnover B) Cash as a percentage of sales C) Amount of credit sales Explanation No inferences about liquidity are warranted based on this measure A rm may have higher credit sales than another simply because it has more sales overall Cash as a proportion of sales and inventory turnover are indicators of liquidity (Study Session 11, Module 35.1, LOS 35.b) Question #19 of 44 Question ID: 1205896 An investment policy statement for a rm's short-term cash management function would least appropriately include: A) procedures to follow if the investment guidelines are violated B) a list of permissible securities C) information on who is allowed to invest corporate cash Explanation An investment policy statement typically begins with a statement of the purpose and objective of the investment portfolio, some general guidelines about the strategy to be employed to achieve those objectives, and the types of securities that will be used A list of permitted securities for investment would be limited and likely too restrictive A list of permitted security types is appropriate and can provide the necessary exibility to increase yield within the safety and liquidity constraints appropriate for the rm (Study Session 11, Module 35.1, LOS 35.e) Question #20 of 44 Question ID: 1205894 A 30-day bank certi cate of deposit has a holding period yield of 1% What is the annual yield of this CD on a bond-equivalent basis? A) 11.83% B) 12.00% C) 12.17% Explanation The bond-equivalent yield is calculated as the holding period yield times (365 / number of days in the holding period) BEY = 1% × (365/30) = 12.17% (Study Session 11, Module 35.1, LOS 35.e) Question #21 of 44 Question ID: 1205911 Which of the following sources of liquidity is the most reliable? A) Uncommitted line of credit B) Revolving line of credit C) Committed line of credit Explanation A revolving line of credit is typically for a longer term than an uncommitted or committed line of credit and thus is considered a more reliable source of liquidity With an uncommitted line of credit, the issuing bank may refuse to lend if conditions of the rm change An overdraft line of credit is similar to a committed line of credit agreement between banks and rms outside of the U.S Both committed and revolving lines of credit can be veri ed and can be listed in the footnotes to a rm's nancial statements as sources of liquidity (Study Session 11, Module 35.1, LOS 35.g) Question #22 of 44 Question ID: 1205875 Alton Industries will have better liquidity than its peer group of companies if its: A) average trade payables are lower B) receivables turnover is higher C) quick ratio is lower Explanation Higher receivables turnover is an indicator of better receivables liquidity since receivables are converted to cash more rapidly A lower quick ratio is an indication of less liquidity Lower trade payables could be related to better liquidity, but could also be consistent with very poor liquidity and a requirement from its suppliers of cash payment (Study Session 11, Module 35.1, LOS 35.b) Question #23 of 44 Question ID: 1205873 An analyst computes the following ratios for Iridescent Carpeting Inc and compares the results to the industry averages: Financial Ratio Iridescent Carpeting Industry Average Current Ratio 2.3x 1.8x Net Pro t Margin 22% 24% Return on Equity 17% 20% Total Debt / Total Capital 35% 56% Times Interest Earned 4.7x 4.1x Based on the above data, which of the following can the analyst conclude? Iridescent Carpeting: A) has better short-term liquidity than its competitors B) is most likely a younger company than its competitors C) has stronger pro tability than its competitors Explanation Based on the data provided, the analyst can conclude that Iridescent Carpeting has weaker pro tability than its competitors based on the net pro t margin and return on equity The analyst can also conclude that the company has less nancial leverage (risk) than the industry average based on the total debt / total capital and the times interest earned ratios The analyst can conclude that the company has better shortterm liquidity than the industry average (i.e., its competitors) based on the current ratio (Study Session 11, Module 35.1, LOS 35.b) Question #24 of 44 Question ID: 1205886 Pierce Motor Company has an operating cycle of 150 days and a cash conversion cycle of 120 days, while Dunhill Motor, Inc has an operating cycle of 140 days and a cash conversion cycle of 125 days Based on these gures it is most likely that: A) average days of inventory for Dunhill is less than for Pierce B) average days of payables for Dunhill is less than for Pierce C) average days of receivables for Dunhill is less than for Pierce Explanation The operating cycle is days of inventory plus days of receivables The cash conversion cycle is the operating cycle minus days of payables Therefore, average days of payables are the operating cycle minus the cash conversion cycle Dunhill's average days of payables (140 – 125 = 15) are less than Pierce's average days of payables (150 – 120 = 30) Which company has higher average days of inventory or receivables cannot be determined from the information provided (Study Session 11, Module 35.1, LOS 35.c) Question #25 of 44 Question ID: 1205907 A company has just received a $5 million shipment from a supplier Its terms of trade credit are 2/15 net 30 It has access to a line of credit with an annualized cost of 9% The best short-term nancing strategy is to pay the invoice: A) immediately B) on day 30 C) on day 15 Explanation The rm receives free short-term nancing through day 15 It should pay with cash (or use the line of credit with an annualized cost of 9%) on day 15 to take advantage of the trade discount Paying immediately is not the best answer because the rm incurs either a nancing charge with the line of credit or lost interest on its funds if paid immediately with cash The cost of foregoing the trade discount and paying on day 30 is {[1 + (0.02/0.98)]365/(30 – 15)} – = 63.49% This cost is much greater than the alternatives (Study Session 11, Module 35.1, LOS 35.f) Question #26 of 44 Question ID: 1205892 Robel Company, which pays no dividends, carries out a 3-for-5 reverse split of its common shares How will this transaction a ect Robel's forecasts of its net cash position? A) No e ect on the short-term forecast but less net cash in the longterm forecast B) More net cash in both the short-term forecast and the long-term forecast C) No e ect because this transaction does not a ect future cash ows Explanation Stock splits and reverse stock splits not a ect a rm's future cash ows unless dividend yields are increased as a result These transactions change the number of shares outstanding but they not raise capital for the rm (Study Session 11, Module 35.1, LOS 35.d) Question #27 of 44 Question ID: 1205887 In reviewing the e ectiveness of a company's working capital management, an analyst has calculated operating cycle and cash conversion cycle measures for the past three years 20X6 20X7 20X8 Operating cycle (number of days) 55 60 62 Cash conversion cycle (number of days) 27 30 32 The trends in the operating cycle and cash conversion cycle most likely indicate: A) slower collections of receivables B) improving liquidity C) stretching of payables Explanation Longer operating and cash conversion cycles are frequently signs of liquidity problems Slower collections or inventory turnover lengthen the operating cycle The cash conversion cycle is also growing longer, which suggests the company is not stretching payables to o set the lengthening operating cycle (Study Session 11, Module 35.1, LOS 35.c) Question #28 of 44 Question ID: 1205910 Which of the following sources of short-term liquidity is considered reliable enough that it can be listed in the footnotes to a rm's nancial statements as a source of liquidity? A) Revolving line of credit B) Factoring agreement C) Uncommitted line of credit Explanation With an uncommitted line of credit, the lender is not committed to make loans in any amount A revolving line of credit is typically for a longer period and involves an agreement to lend funds in the future up to some maximum amount Factoring does not typically involve an agreement for future receivables purchases (Study Session 11, Module 35.1, LOS 35.g) Question #29 of 44 Question ID: 1205870 The condition that occurs when a company disburses cash too quickly, stretching the company's cash reserves, is best described as a: A) pull on liquidity B) drag on liquidity C) liquidity premium Explanation When cash payments are made too quickly, the condition is known as a pull on liquidity A drag on liquidity occurs when cash in ows lag (Study Session 11, Module 35.1, LOS 35.a) Question #30 of 44 Question ID: 1205900 Yields on rms' investments in short-term securities for comparison purposes are best stated as: A) B) C) holding period return ( holding period return ( discount face ( 365 days to maturity 360 days to maturity 360 days to maturity ) ) ) Explanation The yields on investments in short-term securities should be stated as bond equivalent yields (BEYs), and returns on portfolios of these securities should be stated as a weighted average of BEYs The BEY, which is holding period yield × ( 365 days to maturity ) , allows xed-income securities whose payments are not annual to be compared with securities with annual yields (Study Session 11, Module 35.1, LOS 35.e) Question #31 of 44 Question ID: 1205899 A rm is choosing among three short-term investment securities: Security 1: A 30-day U.S Treasury bill with a discount yield of 3.6% Security 2: A 30-day banker's acceptance selling at 99.65% of face value Security 3: A 30-day time deposit with a bond equivalent yield of 3.65% Based only on these securities' yields, the rm would: A) prefer the banker’s acceptance B) prefer the U.S Treasury bill C) prefer the time deposit Explanation We can compare the yields of these securities on any single basis The preferred basis is the bond equivalent yield Security = discount is 3.6%(30 / 360) = 0.3% BEY = (0.3 / 99.7) (365 / 30) = 3.661% BEY of Security = (0.35 / 99.65) × (365 / 30) = 4.273% BEY of Security = 3.65% (Study Session 11, Module 35.1, LOS 35.e) Question #32 of 44 Question ID: 1205891 A rm records the following cash ows on the same day: $250 million from debt proceeds; $100 million funds transferred to a subsidiary; $125 million in interest payments; and $30 million in tax payments The net daily cash position: A) remained the same B) worsened C) improved Explanation Improving a rm's net daily requires more in ows than out ows Debt proceeds are cash in ows while funds transferred to a subsidiary, interest and dividend payments, and tax payments are out ows The net cash change for the day is $250 – $100 – $125 – $30 = –$5 million (Study Session 11, Module 35.1, LOS 35.d) Question #33 of 44 Question ID: 1205884 The average number of days that it takes to turn raw materials into cash proceeds is a rm's: A) operating cycle B) inventory turnover cycle C) receivables cycle Explanation Operating cycle = days of inventory + days of receivables, and is the number of days that it takes to turn raw materials into cash from sales (Study Session 11, Module 35.1, LOS 35.c) Question #34 of 44 Question ID: 1205905 A result that is most likely to give a nancial manager concern that his rm's credit policy may have become too lenient is: A) weighted average collection period has increased B) inventory turnover has decreased considerably C) receivables turnover has increased signi cantly Explanation The weighted average collection period is the average number of days it takes to collect a dollar of receivables A decreased percentage of sales made on credit or an increase in the receivables turnover ratio might result from more strict credit terms Inventory turnover is not directly a ected by credit terms, only though the e ect of credit terms on overall sales (Study Session 11, Module 35.1, LOS 35.f) Question #35 of 44 Question ID: 1205898 A banker's acceptance that is priced at $99,145 and matures in 72 days at $100,000 has a(n): A) money market yield greater than its discount yield B) bond equivalent yield greater than its e ective annual yield C) discount yield greater than its bond equivalent yield Explanation The money market yield is the holding period yield times 360/72 and is always greater than the discount yield which is the actual discount from face value times 360/72, since the holding period yield is always greater than the percentage discount from face value A security's discount yield and its money market yield are always less than its bond equivalent yield, and its e ective annual yield is always greater than its bond equivalent yield (Study Session 11, Module 35.1, LOS 35.e) Question #36 of 44 Question ID: 1205888 The least appropriate security for investing short-term excess cash balances would be: A) bank certi cates of deposit B) preferred stock C) time deposits Explanation While adjustable-rate preferred is an appropriate security for short-term investment of excess cash balances, other preferred shares are not Bank certi cates of deposit and time deposits can be for appropriately short periods (Study Session 11, Module 35.1, LOS 35.d) Question #37 of 44 Question ID: 1205908 A large, creditworthy manufacturing rm would most likely get short-term nancing by: A) factoring its receivables B) issuing commercial paper C) entering into an agreement for a committed line of credit Explanation Large, creditworthy rms can get the lowest cost of nancing by issuing commercial paper Selling receivables to a factor is a higher cost source of funds used by rms with poor credit quality A committed line of credit requires payment of a fee and represents bank borrowing, which would be attractive to a rm that did not have the size or creditworthiness to issue commercial paper (Study Session 11, Module 35.1, LOS 35.g) Question #38 of 44 Question ID: 1205902 An analyst is reviewing the working capital portfolio investment policy of a publicly traded rm Which of the following components of the policy is the analyst least likely to nd acceptable? A) Investments must have an A-1 rating from S&P or an equivalent rating from another agency B) Investments in U.S T-bills, commercial paper, and bank CDs are acceptable unless issued by Stratford Bank C) Authority for selecting and managing short-term investments rests with the rm’s treasurer and any designees selected by the treasurer Explanation An investment policy for short-term portfolios should have the following elements: purpose, authorities, limitations/restrictions, quality, and other items The purpose section should state the general reason the portfolio exists and the general strategy that will be followed The limitations section generally states the types of investments that are or are not acceptable and should note only categories of securities rather than speci c issuers of securities The authorities section should state the executives who will oversee the portfolio The quality section should state guidelines for the credit quality of the investments in the portfolio The "other" section may be used for portfolio requirements not covered in the rst four sections, such as auditing or reporting requirements (Study Session 11, Module 35.1, LOS 35.e) Question #39 of 44 Question ID: 1205906 P uger Company's accounts payable department receives an invoice from a vendor with terms of 2/10 net 30 If P uger pays the invoice on its due date, the cost of trade credit is closest to: A) 44.6% B) 27.9% C) 43.5% Explanation "2/10 net 30" is a discount of 2% of the invoice amount for payment within 10 days, with full payment due in 30 days Cost of trade credit on day 30 = (1 + 0.02 1−0.02 365/ 30−10 ) − = 44.6% (Study Session 11, Module 35.1, LOS 35.f) Question #40 of 44 An example of a primary source of liquidity is: A) ling for bankruptcy Question ID: 1205871 B) using trade credit from vendors C) renegotiating debt agreements Explanation Primary sources of liquidity include cash resulting from selling goods and services, collecting receivables, generating cash from other sources and sources of short-term funding such as trade credit from vendors and lines of credit from banks Filing for bankruptcy and renegotiating debt agreements are secondary sources of liquidity (Study Session 11, Module 35.1, LOS 35.a) Question #41 of 44 Question ID: 1205904 With respect to inventory management,: A) a rm with inventory turnover higher than the industry average can be expected to have better pro tability as a result B) an increase in days of inventory on hand can be the result of either good or poor inventory management C) a decrease in a rm’s days of inventory on hand indicates better inventory management and can lead to increased pro ts Explanation An increase in inventory could indicate poor sales and an accumulation of obsolete items or could be the result of a conscious e ort to have adequate supplies to avoid losses from not having items to satisfy customer orders (stock outs) Higher-than-average inventory turnover could indicate better inventory management or could indicate that a less than optimal inventory is being maintained by the company (Study Session 11, Module 35.1, LOS 35.f) Question #42 of 44 Question ID: 1205874 Which of the following is NOT a limitation to nancial ratio analysis? A) A rm that operates in only one industry B) Di erences in international accounting practices C) The need to use judgment Explanation If a rm operates in multiple industries, this would limit the value of nancial ratio analysis by making it di cult to nd comparable industry ratios (Study Session 11, Module 35.1, LOS 35.b) Question #43 of 44 Question ID: 1205883 An analyst who is evaluating a rm's working capital management would be least likely to be concerned if the rm's: A) operating cycle is shorter than that of its peers B) number of days of inventory is higher than that of its peers C) total asset turnover is lower than its industry average Explanation A shorter operating cycle will lead to a shorter cash conversion cycle, other things equal, which is an indication of better working capital management Higher days inventory on hand, compared to peer company averages, will lengthen the cash conversion cycle, an indication of poorer working capital management Good working capital management would tend to increase a rm's total asset turnover since a given amount of sales can be supported with less working capital (less current assets) (Study Session 11, Module 35.1, LOS 35.c) Question #44 of 44 Question ID: 1205903 Which of the following strategies is most likely to be considered good payables management? A) Paying invoices on the last day to still get the supplier’s discount for early payment B) Taking trade discounts only if the rm’s annual return on short-term investments is less than the discount percentage C) Paying trade invoices on the day they arrive Explanation Paying invoices on the last day to get a discount (for early payment) is likely the most advantageous strategy for a rm If the annualized percentage cost of not taking advantage of the discount is less than the rm's short-term cost of funds, it would be advantageous to pay on the due date However, the discount percentage is not an annualized rate, so it cannot be compared directly to the rm's annual return on short-term investments Paying prior to the discount cut-o date or prior to the due date sacri ces interest income for no advantage (Study Session 11, Module 35.1, LOS 35.f) ... arise from ine ective corporate governance least likely include: A) less e ective decision making B) weaker nancial performance C) reduced default risk Explanation Ine ective corporate governance... Question #19 of 23 Question ID: 1205657 Which of the following statements about corporate governance is most accurate? Corporate governance: A) may be focused only on shareholder interests B) best... Under the shareholder theory of corporate governance, practices are primarily those that support shareholder interests, while under the stakeholder theory of corporate governance, the interests