978-0132757089 Chapter 18 Part 4

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34) A major risk in using commercial paper for short-term financing is the inflexible repayment

schedule.

Topic: 18.4 Managing Current Liabilities

Keywords: commercial paper

Principles: Principle 3: Cash Flows Are the Source of Value

35) Prior to establishing trade credit, the firm is required to make extended formal agreements

with the company.

Topic: 18.4 Managing Current Liabilities

Keywords: trade credit

Principles: Principle 3: Cash Flows Are the Source of Value

36) Lines of credit often require that the borrower maintain a minimum balance in the bank

throughout the loan period.

Topic: 18.4 Managing Current Liabilities

Keywords: line of credit

Principles: Principle 3: Cash Flows Are the Source of Value

37) Trade credit provides one of the most flexible sources of short-term financing available to the

firm.

Topic: 18.4 Managing Current Liabilities

Keywords: trade credit

Principles: Principle 3: Cash Flows Are the Source of Value

38) Commercial paper is an unsecured form of credit.

Topic: 18.4 Managing Current Liabilities

Keywords: commercial paper

Principles: Principle 3: Cash Flows Are the Source of Value

39) Lines of credit involve fixed rates of interest.

Topic: 18.4 Managing Current Liabilities

Keywords: line of credit

Principles: Principle 3: Cash Flows Are the Source of Value

40) Secured loans are those that are secured by the lender’s faith in the ability of the borrower to

repay the funds when due.

Topic: 18.4 Managing Current Liabilities

Keywords: secured current liabilities

Principles: Principle 3: Cash Flows Are the Source of Value

41) Accrued wages and taxes provide sources of financing that rise and fall spontaneously with

the level of the firm’s sales.

Topic: 18.4 Managing Current Liabilities

Keywords: spontaneous sources of financing

Principles: Principle 3: Cash Flows Are the Source of Value

42) Commercial paper offers the borrower the same flexibility that exists when bank credit is

used to meet financing needs.

Topic: 18.4 Managing Current Liabilities

Keywords: commercial paper

Principles: Principle 3: Cash Flows Are the Source of Value

43) Describe the differences between secured and unsecured short-term credit.

Topic: 18.4 Managing Current Liabilities

Keywords: secured current liabilities

Principles: Principle 3: Cash Flows Are the Source of Value

44) Discuss the advantages of using commercial paper.

Topic: 18.4 Managing Current Liabilities

Keywords: commercial paper

Principles: Principle 3: Cash Flows Are the Source of Value

45) Calculate the effective cost of the following trade credit terms if the discount is foregone and

payment is made on the net due date.

a. 2/15 net 30

b. 2/15 net 45

c. 2/15 net 60

Topic: 18.4 Managing Current Liabilities

Keywords: trade credit

Principles: Principle 3: Cash Flows Are the Source of Value

46) The U.R. Bloom Corporation established a line of credit with a local bank. The maximum

amount that can be borrowed under the terms of the agreement is $125,000 at a rate of 5%. A

compensating balance averaging 10% of the loan is required. If the firm needs $100,000 for six

months, what is the dollar cost of the loan and the annual percentage rate (APR)?

Topic: 18.4 Managing Current Liabilities

Keywords: annual percentage rate

Principles: Principle 3: Cash Flows Are the Source of Value

4.5%. What is the annual percentage rate on the loan?

Topic: 18.4 Managing Current Liabilities

Keywords: annual percentage rate

Principles: Principle 3: Cash Flows Are the Source of Value

48) The Smith Corporation has purchased $500,000 worth of inventory. The vendor offers terms

of 1/15 net 45. Unfortunately, Smith does not have enough cash available to take advantage of

the discount. It can borrow $500,000 from Wesson National Bank for 30 days at an annual

percentage rate of 6%. Should Smith forego the discount or pay within the discount period with

money borrowed from the bank?

Topic: 18.4 Managing Current Liabilities

Keywords: annual percentage rate

Principles: Principle 3: Cash Flows Are the Source of Value

49) Lightbulbs.com sells industrial and institutional lighting supplies through its website. It sells

directly to businesses and organizations such as universities and hospitals on terms of net 90. To

finance its rather large investments in receivables and inventory, the firm has an average need for

$2,000,000 in short-term loans. It is choosing between 3 alternative arrangements:

Converse Bank offers a 4.75% APR with interest and principal paid at the end of the year.

Guaranty Bank offers a rate of 4.5% with interest discounted at the time of the loan.

County Bank offers 4.25% with a 10% compensating balance.

Which bank offers the APR when all terms of the loan are considered? You may assume that

required amounts are borrowed for the full year.

Topic: 18.4 Managing Current Liabilities

Keywords: annual percentage rate

Principles: Principle 3: Cash Flows Are the Source of Value

50) The annual percentage rate (APR) on short-term loans from Bank A is 5.75% per year. Bank

B claims that their interest rate is only 5.44% per year. However, Bank B charges interest on a

discount basis. Which bank is charging the lowest APR on a one-year loan?

Topic: 18.4 Managing Current Liabilities

Keywords: annual percentage rate

Principles: Principle 3: Cash Flows Are the Source of Value

1) Which of the following is NOT a typical characteristic of money-market securities?

A) Little or no default risk

B) Liquid, easily bought and sold

C) Interest is not taxable at state or federal level

D) Maturities less than 1 year

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) A disadvantage involved in investing in marketable securities is that:

A) this reduces the risk of illiquidity.

B) this investment increases net working capital.

C) this investment offers a flexible means of financing.

D) these assets offer low rates of return, commensurate with their risk.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) “Float” is the term given to:

A) differences between the cash balance and the balance of cash plus marketable securities.

B) differences between the cash balance in the ledger and the funds available in the firm’s

checking account.

C) the period between the date an invoice is received and the date on which it must be paid.

D) the practice of deliberately delaying payments beyond the due date.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Typical securities in which firms invest their temporary cash surpluses include all of the

following EXCEPT:

A) U. S. Treasury Bills.

B) commercial paper.

C) high quality corporate bonds.

D) Money Market Mutual Funds.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Which of the following would NOT typically be used for assessing customer quality for

purposes of granting trade credit?

A) Ratio analysis

B) Aging of accounts receivable

C) Credit scoring

D) Credit rating services

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: accounts receivable

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Accounts receivable typically comprise ________ of a firm’s assets.

A) 25%

B) 50%

C) less than 1%

D) 10%

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: accounts receivable

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) Which of the following terms would tend to minimize a firm’s investment in accounts

receivable?

A) net 15

B) net 30

C) 1/15 net 45

D) 2/10 net 30

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: accounts receivable

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) Management of a firm’s liquidity involves management of the firm’s investment in current

assets.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: liquidity

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) When faced with a surplus of cash, most firms should stretch their trade accounts.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) T-bills and Treasury bonds are guaranteed by the full faith and credit of the United States and

are therefore default-free.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) A banker’s acceptance is a draft drawn on a specific bank by an exporter in order to obtain

payment for goods that he has shipped to a customer who maintains an account with that specific

bank.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) A negotiable certificate of deposit (CD) is a marketable receipt for funds deposited in a bank.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) Although CDs are slightly more risky than Treasury bills, the yield is usually slightly less.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) If revenues can be forecast to fall within a tight range of outcomes, then the ratio of cash and

near-cash to total assets will be greater for the firm than if the prospective cash inflows might be

expected to vary over a wide range.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Electronic funds transfer (EFT) could eventually eliminate the use of most checks and

minimize float.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) Commercial paper is a short-term, unsecured promissory note.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) One of the attractive features of commercial paper is an active secondary market.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Marketable securities are near-cash assets because they can be converted into cash quickly.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) Investing in additional marketable securities and inventories creates higher profitability and

lower liquidity.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: cash and marketable securities

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) The minimum level of inventory the firm plans to hold for the foreseeable future is a

temporary asset investment.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: inventories

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) Briefly describe at least three useful tools for maintaining control over accounts receivable.

Topic: 18.5 Managing the Firm’s Investment in Current Assets

Keywords: accounts receivable

Principles: Principle 2: There Is a Risk-Return Tradeoff