Question

1) Which of the following will necessarily cause an increase in net working capital?

a) Increasing cash balances.

b) Paying down current liabilities.

c) Issuing shares of stock to purchase fixed assets.

d) Increasing long-term debt to purchase more inventory.

2) A firm has total revenue of $1,000, total expenses of $500, an average tax rate of 30% and a marginal tax rate of 35%. What is the firm's net income?

Please show all steps. Thank you.

Answer 1

1) Ans: D  Increasing long-term debt to purchase more inventory

In option a, increasing cash balances may lead to increase in liabilities and so effect on NWC is uncertain

In option b, paying down current liabilities will use cash and so there is no effect on NWC

In option c, there is no change in NWC because the cash obtained from issuing shares is used to purchase fixed assets

In opton d, long term debt is used to purchase inventory. So, current liabilities remain same while current assets increase and so NWC (CA-CL) increases.

2)Net income = (Revenues-Expenses)*(1-Marginal Tax rate) = (1000-500)*(1-0.35) = $325