Answer (B) is correct . A conservative working capital management financing policy uses permanent capital to finance permanent asset requirements and also some or all of the firm’s seasonal demands. Thus, Lott’s current ratio (current assets/current liabilities) will be high since its current liabilities will be relatively low. An aggressive policy entails financing some fixed assets and all the current assets with short-term capital. This policy results in a lower current ratio.
Answer (A) is incorrect because Clay’s aggressive policy would result in more short-term debt, with attendant renewal problems and high risk. Lott’s conservative policy would produce more long-term debt or equity financing.
Answer (C) is incorrect because Clay is subject to greater liquidity risk than Lott since it has greater short-term debt. Hence, it is at greater risk of being unable to meet its maturing obligations.
Answer (D) is incorrect because A more conservative company would tend to finance by means of equity rather than debt capital. Thus, the more conservative company would have less interest expense.
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