17) Which of the following statements is FALSE?
A) The matching principle indicates that the irm should inance permanent working capital
with short-term sources of funds.
B) Following the matching principle should, in the long run, help minimize a irm’s
transaction costs.
C) In a perfect capital market, the choice of inancing is irrelevant; thus how the irm
chooses to inance its short-term cash needs cannot afect value.
D) A portion of a irm’s investment in its accounts receivable and inventory is temporary
and results from seasonal luctuations in the irm’s business or unanticipated shocks.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
18) Which of the following statements is FALSE?
A) Because investment in permanent working capital is required so long as the irm
remains in business, it constitutes a long-term investment.
B) Because temporary working capital represents a short-term need, the irm should
inance this portion of its investment with short-term inancing.
C) Temporary working capital is the diference between the lowest level of investment in
short-term assets and the permanent working capital investment.
D) The matching principle states that short-term needs should be inanced with short-term
debt and long-term needs should be inanced with long-term sources of funds.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21
19) Which of the following statements is FALSE?
A) With a discount loan, the borrower is required to pay the interest at the end of the loan
period.
B) Bridge loans are often quoted as discount loans with ixed interest rates.
C) A bridge loan is another type of short-term bank loan that is often used to “bridge the
gap” until a irm can arrange for long-term inancing.
D) After a natural disaster, lenders may provide businesses with short-term loans to serve
as bridges until they receive insurance payments or long-term disaster relief.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
20) Which of the following statements is FALSE?
A) Financing part or all of the permanent working capital with short-term debt is known as
an aggressive inancing policy.
B) When the yield curve is downward sloping, the interest rate on short-term debt is lower
than the rate on long-term debt. In that case, short-term debt may appear cheaper than
long-term debt.
C) The value of short-term debt is less sensitive to the irm’s credit quality than long-term
debt; therefore, its value will be less afected by management’s actions or information.
D) Permanent working capital is the amount that a irm must keep invested in its short-
term assets to support its continuing operations.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
22
21) Which of the following statements is FALSE?
A) By relying on short-term debt the irm exposes itself to funding risk, which is the risk of
incurring inancial distress costs if it cannot reinance its debt in a timely manner or at a
reasonable rate.
B) An ultra-conservative policy would involve inancing even some of the plant, property,
and equipment with short-term sources of funds.
C) With a conservative inancing policy, the irm would use short-term debt very sparingly
to meet its peak seasonal needs.
D) Short-term debt can have lower agency and lemons costs than long-term debt, and an
aggressive inancing policy can beneit shareholders.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
22) Which of the following statements is FALSE?
A) When following a conservative inancing policy, a irm would use long-term sources of
funds to inance its ixed assets, permanent working capital, and some of its seasonal
needs.
B) An aggressive inancing policy also increases the possibility that managers of the irm
will use this excess cash nonproductively—for example, on perquisites for themselves.
C) A irm could inance its short-term needs with long-term debt, a practice known as a
conservative inancing policy.
D) To implement a conservative inancing policy efectively, there will necessarily be
periods when excess cash is available—those periods when the irm requires little or no
investment in temporary working capital.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
23
Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table
(in $ millions):
Quarter 1 2 3 4
Cash 605 625 175 1,000
Accounts Receivable 585 745 1,260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1,055 1,145
23) The permanent working capital needs for Hasbeen Toys is closest to ________.
A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
24
24) The temporary working capital needs for Hasbeen Toys in quarter 1 is closest to
________.
A) $0 million
B) $340 million
C) $770 million
D) $845 million
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
25
25) The temporary working capital needs for Hasbeen Toys in quarter 3 is closest to
________.
A) $845 million
B) $0 million
C) $770 million
D) $340 million
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
26) What is permanent working capital?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
27) What is temporary working capital?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
26
20.3 Short-Term Financing with Bank Loans
1) The prime rate is the rate banks charge all but their largest customers, who can
negotiate a sub-prime rate.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) An uncommitted line of credit is obtained through a nonbinding, informal agreement.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) In a single, end-of-period payment loan ________.
A) pay no interest on the loan and pay back the principal in one lump sum at the beginning
of the loan
B) pay no interest on the loan and pay back the principal in one lump sum at the end of the
loan
C) pay interest on the loan and pay back the principal in one lump sum in the beginning of
the loan
D) pay interest on the loan and pay back the principal in one lump sum at the end of the
loan
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4) Which of the following best describes a bank loan arrangement where a bank agrees to
lend a irm any amount up to a stated maximum in an informal agreement which does not
legally bind the bank to provide the funds?
A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
27
5) Which of the following bank loan arrangements is typically accompanied by a
requirement that the irm maintain a minimum level of deposits with the lending bank and
restricts the level of the borrowing irm’s working capital?
A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6) Which of the following is a committed line of credit with no ixed maturity?
A) a bridge loan
B) evergreen credit
C) a promissory note
D) a blanket lien
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) A petroleum exploration company takes a short-term bank loan in order to inance the
purchase of several truck–mounted, vibroseis shakers, which have unexpectedly come onto
the market at a good price. Once the purchase is made, the company will obtain long-term
inancing. Which of the following best describes the short-term loan the company has
taken?
A) a single, end-of-period payment loan
B) a promissory note
C) a bridge loan
D) an uncommitted line of credit
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
28
8) A irm has a committed line of credit with a maximum of $2.5 million and an interest rate
of 9% (EAR) with a certain bank. The commitment fee is 0.65% (EAR). The irm borrows $2
million at the start of the year, and then repays it at the end of the year. What is the total
cost of the loan?
A) $180,000
B) $183,250
C) $193,000
D) $212,500
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
9) A irm has a committed line of credit with a maximum of $10 million and an interest rate
of 8.5% (EAR) with a certain bank. The commitment fee is 0.5% (EAR). The irm borrows $2
million at the start of the year and then repays it at the end of the year. What is the total
cost of the loan?
A) $520,000
B) $680,000
C) $210,000
D) $720,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
29
10) A irm has a committed line of credit with a maximum of $1.2 million and an interest
rate of 12% (EAR) with a certain bank. The commitment fee is 0.6% (EAR). The irm
borrows $500,000 at the start of the year and then repays it at the end of the year. What is
the total cost of the loan?
A) $60,000
B) $64,200
C) $76,300
D) $95,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
11) Crimini Foods is ofered a $400,000 line of credit for six months at an APR of 10%. This
loan has a loan origination fee of 2%. What is the actual six-month interest rate paid,
expressed as an EAR?
A) 7.14%
B) 10.60%
C) 11.03%
D) 14.80%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
30