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CMA Intermediate · Financial Management and Business Data Analytics · Financing Working Capital

A firm moves from a conservative to an aggressive working capital financing policy, keeping total assets unchanged. Which combination of effects is most likely?

Higher profitability and higher risk. Moving to an aggressive policy substitutes cheaper short-term funds for long-term funds, which cuts financing cost. But more frequent renewal and a thinner liquidity cushion raise the chance of a cash crunch, so risk rises with return.

  1. ALower profitability and lower risk
  2. BHigher profitability and higher riskCorrect
  3. CHigher profitability and lower risk
  4. DLower profitability and higher risk

Explanation

An aggressive policy replaces costlier long-term funds with cheaper short-term funds, raising expected profitability. However, it increases refinancing and liquidity risk, as short-term debt must be renewed often and net working capital shrinks. The option pairing higher profit with lower risk ignores this trade-off.

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