AICPA Exam CPA-Business Topic 1 Question 49 Discussion

Choice 'c' is correct. 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.

Choice 'a' is incorrect. Changing the capital structure (common stock vs. preferred stock vs. long-term debt) and dividend policy has nothing to do with the level of working capital required for day-to-day operations of the business.

Choice 'b' is incorrect. The relative interest cost of short-term vs. long-term debt does not determine the appropriate level of working capital.

Choice 'd' is incorrect. Because profitability varies inversely with liquidity, maximizing the return on total investments would require a low (not high) level of liquid assets and a high level of liquid assets does nothing to determine the required level of working capital.