Chapter 16 – Page 1
(Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Current asset financing policy Answer: a Diff: E
1
. Firms generally choose to finance temporary assets with short-term debt because
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than long-term interest
rates.
c. A firm that borrows heavily long-term is more apt to be unable to repay the debt than
a firm that borrows heavily short-term.
d. The yield curve has traditionally been downward sloping.
e. Sales remain constant over the year, and financing requirements also remain constant.
Current asset financing Answer: e Diff: E N
2
. Which of the following statements is most correct?
a. Permanent current assets are those current assets that must be increased when sales
increase during an upswing.
b. Temporary current assets are those current assets on hand at the low point of the
business cycle.
c. Maturity matching is considered an aggressive financing policy.
d. An aggressive current asset financing policy uses a minimum amount of short-term debt.
e. None of the statements above is correct.
Commercial paper Answer: d Diff: E
3
. Which of the following statements concerning commercial paper is incorrect?
a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate below the prime rate.
c. Commercial paper is sold to money market mutual funds, as well as to other financial
institutions and nonfinancial corporations.
d. Commercial paper can be issued by virtually any firm so long as it is willing to pay
the going interest rate.
e. Commercial paper is a type of unsecured promissory note issued by large, strong firms.
Working capital financing Answer: e Diff: E
4
. Which of the following statements is most correct?
a. Trade credit is provided to a business only when purchases are made.
b. Commercial paper is a form of short-term financing that is primarily used by large,
financially stable companies.
c. Short-term debt, while often cheaper than long-term debt, exposes a firm to the
potential problems associated with rolling over loans.
d. Statements b and c are correct.
e. All of the statements above are correct.
CHAPTER 16
FINANCING CURRENT ASSETS
Chapter 16 – Page 2
Working capital financing Answer: a Diff: E
5
. Which of the following statements is incorrect?
a. Commercial paper can be issued by virtually any firm so long as it is willing to pay
the going interest rate.
b. Accrued liabilities represent a source of “free” financing in the sense that no
explicit interest is paid on these funds.
c. A conservative approach to working capital will result in all permanent assets being
financed using long-term securities.
d. The risk to the firm of borrowing with short-term credit is usually greater than with
long-term debt. Added risk can stem from greater variability of interest costs on
short-term debt.
e. Trade credit is often the largest source of short-term credit.
Medium:
Working capital financing policy Answer: c Diff: M
6
. Ski Lifts Inc. is a highly seasonal business. The following summary balance sheet provides
data for peak and off-peak seasons (in thousands of dollars):
Peak Off-peak
Cash $ 50 $ 30
Marketable securities 0 20
Accounts receivable 40 20
Inventories 100 50
Net fixed assets 500 500
Total assets $690 $620
Spontaneous liabilities $ 30 $ 10
Short-term debt 50 0
Long-term debt 300 300
Common equity 310 310
Total claims $690 $620
From this data we may conclude that
a. Ski Lifts has a working capital financing policy of exactly matching asset and
liability maturities.
b. Ski Lifts’ working capital financing policy is relatively aggressive; that is, the
company finances some of its permanent assets with short-term discretionary debt.
c. Ski Lifts follows a relatively conservative approach to working capital financing;
that is, some of its short-term needs are met by permanent capital.
d. Without income statement data, we cannot determine the aggressiveness or conservatism
of the company’s working capital financing policy.
e. Statements a and c are correct.
Working capital financing policy Answer: b Diff: M
7
. Which of the following statements is most correct?
a. Net working capital may be defined as current assets minus current liabilities. Any
increase in the current ratio will automatically lead to an increase in net working
capital.
b. Although short-term interest rates have historically averaged less than long-term
rates, the heavy use of short-term debt is considered to be an aggressive strategy
because of the inherent risks of using short-term financing.
c. If a company follows a policy of “matching maturities,” this means that it matches its
use of common stock with its use of long-term debt as opposed to short-term debt.
Chapter 16 – Page 3
d. All of the statements above are correct.
e. None of the statements above is correct.
Working capital financing policy Answer: c Diff: M
8
. Which of the following statements is most correct?
a. Accrued liabilities are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances all of its fixed
assets with long-term capital and part of its permanent current assets with short-
term, nonspontaneous credit.
c. If a company receives trade credit under the terms 2/10 net 30, this implies the
company has 10 days of free trade credit.
d. Statements a and b are correct.
e. None of the answers above is correct.
Short-term financing Answer: a Diff: M
9
. Which of the following statements is most correct?
a. Under normal conditions, a firm’s expected ROE would probably be higher if it financed
with short-term rather than with long-term debt, but the use of short-term debt would
probably increase the firm’s risk.
b. Conservative firms generally use no short-term debt and thus have zero current
liabilities.
c. A short-term loan can usually be obtained more quickly than a long-term loan, but the
cost of short-term debt is likely to be higher than that of long-term debt.
d. If a firm that can borrow from its bank buys on terms of 2/10, net 30, and if it must
pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on
its balance sheet.
e. If one of your firm’s customers is “stretching” its accounts payable, this may be a
nuisance but does not represent a real financial cost to your firm as long as the firm
periodically pays off its entire balance.
Short-term versus long-term financing Answer: d Diff: M
10
. Which of the following statements is most correct?
a. Under normal conditions the shape of the yield curve implies that the interest cost of
short-term debt is greater than that of long-term debt, although short-term debt has
other advantages that make it desirable as a financing source.
b. Flexibility is an advantage of short-term credit but this is somewhat offset by the
higher flotation costs associated with the need to repeatedly renew short-term credit.
c. A short-term loan can usually be obtained more quickly than a long-term loan but the
penalty for early repayment of a short-term loan is significantly higher than for a
long-term loan.
d. Statements about the flexibility, cost, and riskiness of short-term versus long-term
credit are dependent on the type of credit that is actually used.
e. Short-term debt is often less costly than long-term debt and the major reason for this
is that short-term debt exposes the borrowing firm to much less risk than long-term
debt.
Choosing a bank Answer: e Diff: M
11
. Which one of the following aspects of banks is considered most relevant to businesses
when choosing a bank?
a. Convenience of location.
b. Competitive cost of services provided.
Chapter 16 – Page 4
c. Size of the bank’s deposits.
d. Experience of personnel.
e. Loyalty and willingness to assume lending risks.
Multiple Choice: Problems
Easy:
Maturity matching Answer: e Diff: E
12
. Wildthing Amusement Company’s total assets fluctuate between $320,000 and $410,000, while
its fixed assets remain constant at $260,000. If the firm follows a maturity matching or
moderate working capital financing policy, what is the likely level of its long-term
financing?
a. $ 90,000
b. $260,000
c. $350,000
d. $410,000
e. $320,000
Cost of trade credit Answer: a Diff: E R
13
. A firm is offered trade credit terms of 3/15, net 45 days. The firm does not take the
discount, and it pays after 67 days. What is the nominal annual cost of not taking the
discount? (Assume a 365-day year.)
a. 21.71%
b. 22.07%
c. 22.95%
d. 23.48%
e. 24.52%
Cost of trade credit Answer: d Diff: E R
14
. Dixie Tours Inc. buys on terms of 2/15, net 30 days. It does not take discounts, and it
typically pays 35 days after the invoice date. Net purchases amount to $720,000 per
year. What is the nominal annual cost of its non-free trade credit? (Assume a 365-day
year.)
a. 17.2%
b. 23.6%
c. 26.1%
d. 37.2%
e. 50.6%
Cost of trade credit Answer: b Diff: E R
15
. Your company has been offered credit terms on its purchases of 4/30, net 90 days. What
will be the nominal annual cost of trade credit if your company pays on the 35th day
after receiving the invoice? (Assume a 365-day year.)
a. 30%
b. 304%
c. 3%
d. 87%
e. 156%
Chapter 16 – Page 5
Free trade credit Answer: a Diff: E R
16
. Phillips Glass Company buys on terms of 2/15, net 30 days. It does not take discounts,
and it typically pays 30 days after the invoice date. Net purchases amount to $730,000
per year. On average, how much “free” trade credit does Phillips receive during the
year? (Assume a 365-day year.)
a. $30,000
b. $40,000
c. $50,000
d. $60,000
e. $70,000
Free trade credit Answer: b Diff: E N
17
. HBC Inc. buys on terms of 2/10, net 30 days. It does not take discounts, and it
typically pays 30 days after the invoice date. Net purchases amount to $1,750,000 per
year. On average, how much “free” trade credit does HBC receive during the year?
(Assume a 365-day year.)
a. $25,293.45
b. $47,945.21
c. $68,651.33
d. $75,000.00
e. $95,890.42
Nominal interest rate Answer: d Diff: E
18
. Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The bank offers the
choice of a 12 percent discount interest loan or a 10.19 percent add-on, 1-year
installment loan, payable in 4 equal quarterly payments. What is the approximate
(nominal) rate of interest on the 10.19 percent add-on loan?
a. 5.10%
b. 10.19%
c. 12.00%
d. 20.38%
e. 30.57%
Discount interest face value Answer: c Diff: E
19
. Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and
harvest its fruit crop. Picard borrows on a discount interest basis at a nominal annual
rate of 11 percent. If Picard must actually receive $100,000 net proceeds to finance its
crop, then what must be the face value of the note?
a. $111,000
b. $100,000
c. $112,360
d. $ 89,000
e. $108,840
Discount interest face value Answer: a Diff: E
20
. Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year. The firm
receives payment from its harvests sometime after shipment. Due in part to the firm’s
rapid growth, it has been borrowing to finance its harvests using 90-day bank notes on
which the firm pays 12 percent discount interest. If the firm requires $60,000 in
proceeds from each note, what must be the face value of each note?
Chapter 16 – Page 6
a. $61,856
b. $67,531
c. $60,000
d. $68,182
e. $67,423
Revolving credit agreement cost Answer: b Diff: E
21
. Inland Oil arranged a $10,000,000 revolving credit agreement with a group of small banks.
The firm paid an annual commitment fee of one-half of one percent of the unused balance
of the loan commitment. On the used portion of the loan, Inland paid 1.5 percent above
prime for the funds actually borrowed on an annual, simple interest basis. The prime rate
was at 9 percent for the year. If Inland borrowed $6,000,000 immediately after the
agreement was signed and repaid the loan at the end of one year, what was the total
dollar cost of the loan agreement for one year?
a. $560,000
b. $650,000
c. $540,000
d. $900,000
e. $675,000
Medium:
Accounts payable balance Answer: e Diff: M R
22
. Your firm buys on credit terms of 2/10, net 45 days, and it always pays on Day 45. If
you calculate that this policy effectively costs your firm $159,621 each year, what is
the firm’s average accounts payable balance? (Hint: Use the nominal cost of trade
credit and carry its cost out to 6 decimal places.)
a. $1,234,000
b. $ 75,000
c. $ 157,500
d. $ 625,000
e. $ 750,000
EAR cost of trade credit Answer: e Diff: M R
23
. Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days.
Out of convenience, your firm is not taking discounts, but is paying after 20 days,
instead of waiting until Day 30. You point out that the nominal cost of not taking the
discount and paying on Day 30 is approximately 37 percent. But since your firm is not
taking discounts and is paying on Day 20, what is the effective annual cost of your
firm’s current practice, using a 365-day year?
a. 36.7%
b. 105.4%
c. 73.4%
d. 43.6%
e. 109.0%
EAR cost of trade credit Answer: e Diff: M R
24
. Hayes Hypermarket purchases $4,562,500 in goods over a 1-year period from its sole
supplier. The supplier offers trade credit under the following terms: 2/15, net 50
days. If Hayes chooses to pay on time but not to take the discount, what is the average
level of the company’s accounts payable, and what is the effective annual cost of its
trade credit? (Assume a 365-day year.)
a. $208,333; 17.81%
b. $416,667; 17.54%
c. $416,667; 27.43%
d. $625,000; 17.54%
e. $625,000; 23.45%
EAR cost of trade credit Answer: d Diff: M N
25
. A firm is offered trade credit terms of 3/15, net 30 days. The firm does not take the
discount, and it pays after 50 days. What is the effective annual cost of not taking
this discount? (Assume a 365-day year.)
a. 44.30%
b. 32.25%
c. 30.00%
d. 37.39%
e. 45.50%
EAR cost of trade credit Answer: d Diff: M R
26
. A firm is offered trade credit terms of 2/8, net 45 days. The firm does not take the
discount, and it pays after 58 days. What is the effective annual cost of not taking
this discount? (Assume a 365-day year.)
a. 21.63%
b. 13.35%
c. 14.90%
d. 15.89%
