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Answers to concepts review and critical thinking questions. Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. It"s desirable for firms to have high liquidity so that they have a large factor of safety in meeting short-term creditor demands. However, since liquidity also has an opportunity cost associated with it namely that higher returns can generally be found by investing the cash into productive assets low liquidity levels are also desirable to the firm. It"s up to the firm"s financial management staff to find a reasonable compromise between these opposing needs. Note that this way is not necessarily correct; it"s the way accountants have chosen to do it. Historical costs can be objectively and precisely measured whereas market values can be difficult to estimate, and different analysts would come up with different numbers. Thus, there is a tradeoff between relevance (market values) and objectivity (book values).

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