1) A firm buys on terms of 3/10, net 30. What is the cost of trade credit under these terms?
A) 55.7%
B) 47.4%
C) 31.5%
D) 23.2%
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
2) The correct equation for calculating the cost of short-term credit is:
A) rate = interest/(principal × time).
B) rate = (principal × time)/interest.
C) rate = principal/(time × interest).
D) rate = principal × interest × time.
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
3) Which item would constitute poor collateral for an inventory loan?
A) Lumber
B) Vegetables
C) Copper
D) Chemicals
Topic: 18.4 Managing Current Liabilities
Keywords: secured current liabilities
Principles: Principle 3: Cash Flows Are the Source of Value
4) Which of the following statements regarding a line of credit is true?
A) The purpose for which the money is being borrowed must be stated by the borrower.
B) A line of credit agreement usually fixes the interest rate that will be applied to any extensions
of credit.
C) A line of credit agreement is a legal commitment on the part of the bank to provide the stated
credit.
D) Such agreements usually cover the borrower’s fiscal year.
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
21
5) Which of the following is an advantage of using commercial paper for short-term credit?
A) The ability of some firms to obtain large amounts of credit
B) A readily available source of credit for most firms
C) It is a type of free credit
D) It can be issued for very small amounts
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
6) The First Webster Bank requires borrowers to maintain a balance of 10% of the line of credit
in a non-interest paying account as compensation for providing the line of credit. If the borrower
would not normally have deposits in such an account, the APR will be:
A) the amount borrowed will be higher than the amount needed.
B) the APR will be less than the stated rate.
C) the amount borrowed will be lower than the amount needed.
D) neither the amount borrowed nor the APR will be affected by the required balance.
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
7) A company which foregoes the discount when credit terms are 4/15 net 70 is essentially
borrowing money from his supplier for an additional:
A) 40 days.
B) 55 days.
C) 70 days.
D) 85 days.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
8) A company that foregoes a discount of 1/7 net 30 is essentially borrowing money from the
vendor at:
A) 1%.
B) 12.29%.
C) 16%.
D) 52.7%.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
22
9) What factors should we consider when selecting a source of short-term credit?
A) Effective cost and availability
B) Liquidity and profitability
C) Historical trend analysis and liquidity
D) None of the above
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
10) Once a cash discount period has passed:
A) one should pay immediately.
B) there is no financial incentive to pay before the final due date.
C) one should pay after the final due date.
D) cannot be determined from the information.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
9.5%. Bank Two requires Capital to maintain compensating balances equal to 10% of the amount
of the line. Assuming that Capital would not normally carry any deposits at the bank, what is the
effective annual rate of interest on the loan?
A) 9.5%
B) 10.6%
C) 11.6%
D) 12.3%
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
12) The Stant Shoe Company established a line of credit with a local bank. The maximum
5%. A compensating balance of 10% of the amount borrowed is required. What is the largest
amount of money Stant will actually be able to use from the line of credit?
A) $90,909
B) $90,000
C) $111,111
D) $100,000
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
23
01 percent)?
A) 5.93%
B) 5.84%
C) 5.64%
D) 5.56%
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
14) Georgia Peaches Corporation (GPC) has a line of credit with Trust Company Bank that
allows GPC to borrow up to $300,000 at an annual interest rate of 5.5%. However, GPC must
keep a compensating balance of 20% of any amount borrowed on deposit at the Trust Company
Bank. GPC does not normally have a cash balance account with the Trust Company. What is the
effective annual cost of credit?
A) 6.875%
B) 6.975%
C) 7.075%
D) 7.775%
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
15) Which of the following comparisons between short-term bank loans is correct?
A) Commercial paper interest rates are usually slightly higher than rates on bank loans.
B) Commercial paper is only appropriate for firms requiring a limited amount of short-term
financing, while banks can offer substantially larger amounts of funds.
C) Banks demand that borrowers meet exacting credit-worthiness tests, while the lenders that
purchase commercial paper are less strict. Only the most credit-worthy borrowers have access to
bank loans.
D) None of the above.
Topic: 18.4 Managing Current Liabilities
Keywords: temporary sources of financing
Principles: Principle 3: Cash Flows Are the Source of Value
24
16) The Stoney River Textiles Company will borrow $50 million for 180 days from Merrimac
Bank. The bank will charge Stoney River 4.5 % on a discounted basis. What is the annual
percentage rate (APR) to Stoney River (round to the nearest .1 percent)?
A) 2.25%
B) 2.36%
C) 4.71%
D) 4.5%
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
17) The Stoney River Textiles Company will borrow $50 million for 180 days from Merrimac
Bank. The bank will charge Stoney River 4.5 % on a discounted basis. What is the dollar amount
of interest Stoney River will need to pay? Assume a 360 day year.
A) $1,125,000
B) $1,099,688
C) $2,250,000
D) 41,074,375
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
18) The annual cost of not taking advantage of the 3/10, net 30 terms offered by a supplier is
(hint: use $1.00 as the invoice amount and a 360-day year):
A) 55.7%.
B) 45.4%.
C) 32.3%.
D) 28.2%.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
25
19) Atlas Tire Irons, Inc. is considering borrowing $5,000 for a 3 month period. The firm will
repay the $5,000 principal amount plus $150 in interest. What is the annual percentage rate
(APR) rate of interest (use a 360-day year)?
A) 3%
B) 12%
C) 15%
D) 18%
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
20) Which of the following would NOT be considered an unsecured loan?
A) Accrued tax payments
B) Line of credit
C) Transaction loans
D) Factored accounts receivable
Topic: 18.4 Managing Current Liabilities
Keywords: factoring
Principles: Principle 3: Cash Flows Are the Source of Value
21) The primary advantage that factoring accounts receivable provides is:
A) the flexibility it gives to the borrower.
B) that the financial institution bears the risk of collection.
C) the low cost as compared with other sources of short-term financing.
D) that the financial institution services the accounts.
Topic: 18.4 Managing Current Liabilities
Keywords: factoring
Principles: Principle 3: Cash Flows Are the Source of Value
22) The Omega Corp. plans to borrow $10,000 for a 2 months. At maturity, Omega will repay the
$10,000 principal plus $100 interest. What is the annual percentage rate (APR) rate of interest on
this loan?
A) 6%
B) 1%
C) 4%
D) 6.4%
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
26
23) The cost of trade credit varies with the:
A) size of the cash discount.
B) length of time between the end of the discount period and the final due date.
C) length of time between the end of the discount period and when the firm purchased from the
supplier.
D) both A and C.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
24) Which of the following is an advantage of trade credit?
A) Trade credit is conveniently obtained as a normal part of the firm’s operations.
B) No formal agreements are generally involved in extending credit.
C) The amount of credit extended expands and contracts with the needs of the firm.
D) All of the above.
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
Use the following information to answer the following question(s).
Quick Corp. makes its purchases under terms of 2/10 net 30.
25) If Quick Corp. foregoes the discount and pays for its purchases according to the terms of its
trade credit, what is Quick’s effective cost of using this source of credit?
A) 26.67%
B) 31.48%
C) 36.73%
D) 51.32%
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
27
26) If Quick foregoes the discount but does not pay for its purchases until day 40, what is
Quick’s effective cost of using this source of credit? Assume that no penalty is incurred for late
payment.
A) 38.37%
B) 36.73%
C) 26.67%
D) 24.49%
Topic: 18.4 Managing Current Liabilities
Keywords: trade credit
Principles: Principle 3: Cash Flows Are the Source of Value
27) When a commercial bank extends short-term credit to a firm, it can provide a line of credit
that involves:
A) a legal obligation on the part of the bank to provide the stated credit.
B) no legal obligation on the part of the bank to provide the stated credit.
C) the requirement that the borrower maintain a compensating balance with the bank throughout
the loan period.
D) a fixed rate of interest.
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
Use the following information to answer the following question(s).
ABC, Inc. requires $270,000 in short-term credit and is currently arranging a loan with its bank.
ABC plans to use the funds for six months, the annual rate on the loan is 12%, and the bank will
require a 10% compensating balance.
28) If ABC must have loan proceeds of $270,000, then it must borrow:
A) $270,000.
B) $300,000.
C) $410,000.
D) $500,000.
Topic: 18.4 Managing Current Liabilities
Keywords: line of credit
Principles: Principle 3: Cash Flows Are the Source of Value
28
29) What is the annual percentage cost of the loan?
A) 15.67%
B) 14.00%
C) 13.33%
D) .83%
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
30) A firm will borrow $1 million for six months on a discount basis. The annual interest rate on
the loan is 12%. What is the annual percentage cost of the loan?
A) 11.00%
B) 12.77%
C) 13.00%
D) 14.23%
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
31) Pledging accounts receivable as a source of short-term credit:
A) is a type of loan secured by accounts receivable.
B) is a form of spontaneous credit.
C) involves the outright sale of accounts receivable to a financial institution.
D) is an inexpensive but risky source of short-term financing.
Topic: 18.4 Managing Current Liabilities
Keywords: secured current liabilities
Principles: Principle 3: Cash Flows Are the Source of Value
32) The effective cost to the borrower of an unsecured bank loan is increased if a compensating
balance is required.
Topic: 18.4 Managing Current Liabilities
Keywords: annual percentage rate
Principles: Principle 3: Cash Flows Are the Source of Value
33) Commercial paper is a source of credit available to large firms with healthy balance sheets.
Topic: 18.4 Managing Current Liabilities
Keywords: commercial paper
Principles: Principle 3: Cash Flows Are the Source of Value
29