978-0134083285 Chapter 15 Part 3

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8) Major sources of secured credit include commercial banks, finance companies, and factors.

Keywords: Secured Credit, Commercial Banks, Finance Companies, Factors

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

9) The cost of trade credit varies directly with the size of the cash discount and inversely with the length

of time between the end of the discount period and the final due date.

Keywords: Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

10) The effective cost to the borrower of an unsecured bank loan is increased if a compensating balance is

required.

Keywords: Effective Cost, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

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

Keywords: Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

12) The amount that can be obtained on an inventory loan depends on both the marketability and

perishability of the items in the inventory.

Keywords: Inventory Loan, Marketability, Perishability

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

13) When the accounts receivable of a firm have been factored, bad debt losses remain the responsibility

of the borrowing firm and must be made good.

Keywords: Factoring Accounts Receivable, Bad Debts

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

14) Under terms of a field warehouse financing agreement, the collateral inventories are physically

separated from the borrower’s other inventories but remain under the borrower’s control.

Keywords: Field Warehouse Financing Agreement, Collateral Inventories

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

15) Trade credit appears on a company‘s balance sheet as accounts payable.

Keywords: Trade Credit, Accounts Payable

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

16) A revolving credit agreement is a legally binding agreement between a borrower and lender.

Keywords: Revolving Credit Agreement

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

17) Issuers of commercial paper usually maintain lines of credit with banks to back up their short-term

financing needs.

Keywords: Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

18) The primary sources of collateral for secured loans are accounts receivable and inventory.

Keywords: Secured Loans, Collateral, Accounts Receivable, Inventory

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

19) Commercial paper is an unsecured form of credit.

Keywords: Commercial Paper, Unsecured Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

20) In a chattel mortgage, specific items of inventory are identified in the security agreement.

Keywords: Chattel Mortgage

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

21) A bank is legally obligated to provide credit under a revolving credit agreement, but not under a line

of credit.

Keywords: Line of Credit, Revolving Credit Agreement

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

22) The inclusion of a compensating balance requirement in a line of credit will reduce the effective

annual cost of credit since the bank has additional collateral for the borrowing.

Keywords: Compensating Balance, Line of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

23) Both compensating balances and discounting interest increase the effective interest rate on a loan.

Keywords: Compensating Balance, Discounting Interest, Effective Interest Rate

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

24) Because only the largest and most creditworthy companies are able to use commercial paper, the

interest rate on commercial paper is generally lower than the prime rate.

Keywords: Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

25) Parsons Company has a cash flow problem. The company owes its suppliers $300,000 on credit terms

of 2/10 net 40, but Parsons doesn’t have the cash to pay during the discount period. Parsons, however, can

borrow the $300,000 at annual rate of 24%. Should Parsons borrow the money to pay its accounts

payable?

A) No, additional borrowing will cost more for interest ($60,000 per year) than the discount is worth.

B) Yes, the effective cost of forgoing the discount is greater than 24%.

C) No, the effective cost of forgoing the discount is equal to 24%, and there are transactions costs

associated with borrowing.

D) It doesn‘t matter because the present value of the cost of borrowing is exactly equal to the amount of

the discount for paying within 10 days.

Keywords: Cash Discount, Effective Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

26) Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase

of $20,000 today. Which of the following payment options makes the most sense as a general rule?

A) Pay the bill as soon as possible to keep the supplier happy.

B) Pay the bill on day 45 due to the time value of money.

C) Pay the bill on day 10 to get the discount.

D) Either pay the bill on day 10 to get the discount, or wait until day 45.

Keywords: Credit Terms, Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

27) As a company accounts payable manager, which of the following credit terms are most likely to entice

you to take the cash discount?

A) 1/10 net 45

B) 2/10 net 60

C) 1/10 net 30

D) 2/10 net 90

Keywords: Cash Discount, Effective Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

28) You are working on your company‘s cash budget for the coming year and you believe there may be

short periods of time where financing is required. Which of the following sources of short-term financing

is most certain to be available when needed?

A) trade credit

B) line of credit with a bank

C) revolving credit agreement with a bank

D) accounts receivable

Keywords: Short-term Financing, Revolving Credit Agreement, Line of Credit, Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

29) All of the following are likely to increase the cost of a company‘s short–term financing EXCEPT

A) an increase in the bank’s prime lending rate.

B) an increase in the compensating balance required.

C) taking a loan on a discount basis.

D) an increase in the company‘s debt rating by Moody‘s or Standard and Poors.

Keywords: Short-term Financing, Prime Rate, Discount Loan, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

30) Brown Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a

bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan

compensating balance. Currently, Brown Inc. has no funds on deposit with the bank and will need the

loan to cover the compensating balance as well as their other financing needs. How much will Brown Inc.

need to borrow?

A) $270,000

B) $300,000

C) $312,500

D) $347,222

Keywords: Compensating Balance, Line of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

31) Brown Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a

bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan

compensating balance. Currently, Brown Inc. has no funds on deposit with the bank and will need the

loan to cover the compensating balance as well as their other financing needs. What will be the annual

percentage rate, or APR, for this financing?

A) 10.00%

B) 12.12%

C) 10.67%

D) 13.33%

Keywords: Compensating Balance, Annual Percentage Rate, Line of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

32) Brown Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a

bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan

compensating balance. Currently, Brown Inc. has no funds on deposit with the bank and will need the

loan to cover the compensating balance as well as their other financing needs. What is the annual

percentage rate for this financing assuming discounted interest?

A) 14.29%

B) 12.98%

C) 11.67%

D) 10.53%

Keywords: Compensating Balance, Discount Interest, Annual Percentage Rate, Line of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

33) All of the following are potential advantages of commercial paper EXCEPT

A) flexible repayment terms.

B) lower interest rates than comparable sources of short-term financing.

C) no compensating balance requirements.

D) ability to borrow very large amounts.

Keywords: Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

34) Marley Financial plans to sell $50,000,000 of 120-day commercial paper, on which it expects to pay

discounted interest at a rate of 5% per year. Dealer fees are expected to be $30,000. The effective cost of

credit to Marley Financial is

A) 5.27%.

B) 5.64%.

C) 6.22%.

D) 7.53%.

Keywords: Commercial Paper, Annual Percentage Rate, Discount Interest

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

35) Which of the following sources of short-term financing is likely to have the lowest interest rate?

A) accounts receivable loan (pledging of accounts receivable)

B) line of credit

C) line of credit with a compensating balance

D) commercial paper

Keywords: Short-term Financing, Commercial Paper, Line of Credit, Pledging Accounts Receivable

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

36) Hyper Retail Outlets sell goods on terms of net 40. The store‘s average monthly sales (all on credit) are

$70,000. Hyper pledges all of its receivables to the bank, which advances 80% of the face value of the

receivables at a rate of 2.5% above prime. The bank also charges a 1% processing fee on all receivables

pledged. Hyper borrows the full amount possible, and the current prime rate is 5%. What is the annual

percentage rate (APR) of using this source of financing for one full year?

A) 23.5%

B) 22.5%

C) 21.8%

D) 19.1%

Keywords: Pledging Accounts Receivable, Annual Percentage Rate

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

37) Which of the following sources of short-term financing is likely to have the highest interest rate?

A) accounts receivable loan (pledging of accounts receivable)

B) line of credit

C) line of credit with a compensating balance

D) commercial paper

Keywords: Short-term Financing, Commercial Paper, Line of Credit, Pledging Accounts Receivable

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

38) Which of the following is NOT an advantage of trade credit?

A) The amount of extended credit expands and contracts with the needs of the firm.

B) The cost of forgoing the discount is less than the prime rate.

C) Generally no formal agreements are involved in the extension of trade credit.

D) Trade credit is very flexible.

Keywords: Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

39) 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.

Keywords: Line of Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

40) Which item would constitute poor collateral for an inventory loan?

A) lumber

B) vegetables

C) grain

D) chemicals

Keywords: Inventory Loan, Collateral

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

41) The inventory loan arrangement in which all of the borrower’s inventories are used as collateral is

termed a

A) terminal warehouse agreement.

B) floating lien agreement.

C) chattel mortgage agreement.

D) field warehouse financial agreement.

Keywords: Inventory Loan, Floating Lien Agreement

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

42) The inventory loan agreement in which the lender can increase his or her security interest by having

specific items of inventory identified in the loan agreement is called

A) a floating lien agreement.

B) a chattel mortgage agreement.

C) a field warehouse agreement.

D) inventory identification agreement.

Keywords: Chattel Mortgage

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

43) The prime rate of interest is

A) the rate the bank charges its most creditworthy borrowers.

B) the rate the bank charges for money it borrows from the Federal Reserve Board.

C) the rate the bank charges its average borrower.

D) the rate the bank charges on home mortgages.

Keywords: Prime Rate

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

44) Terminal warehouse agreements

A) are particularly useful where large bulky items are used as collateral.

B) give the lender a lien against all inventories while only removing representative items.

C) remove control of the inventory from the borrower.

D) are less costly than field warehouse agreements.

Keywords: Terminal Warehouse Agreements

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

45) An inventory loan agreement in which the inventories pledged as collateral are physically separated

from the firm’s other inventory and placed under the control of a third-party is called

A) a floating lien agreement.

B) a chattel mortgage agreement.

C) a field warehouse agreement.

D) a securitized inventory loan arrangement.

Keywords: Field Warehouse Financing Agreement

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

46) A company that forgoes the discount when credit terms are 2/10 net 60 is essentially borrowing

money from his supplier for an additional

A) 10 days.

B) 50 days.

C) 60 days.

D) 70 days.

Keywords: Cash Discount, Credit Terms

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

47) Which of the following loans provide the least amount of security to the lender?

A) chattel mortgage

B) factoring

C) floating lien

D) terminal warehouse agreement

Keywords: Floating Lien

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

48) Which of the following is NOT a source of unsecured short-term credit?

A) trade credit

B) a line of credit

C) floating lien

D) commercial paper

Keywords: Unsecured Short-term Credit

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

49) The Boyles Ceramics, Inc. established a line of credit with a local bank. The maximum amount that

can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A

compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement,

Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay

off a note that was due. It borrowed the $240,000 from the bank by drawing on the line of credit. What is

the effective annual cost of credit?

A) 12.50%

B) 11.11%

C) 10.67%

D) 8.85%

Keywords: Effective Cost of Credit, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

50) The Boyles Ceramics, Inc. established a line of credit with a local bank. The maximum amount that

can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A

compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement,

Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay

off a note that was due. Boyles decides to borrow an amount sufficient to pay the $240,000 note and also

to cover the compensating balance. How much must Boyles Glass borrow?

A) $300,000

B) $320,000

C) $375,000

D) $400,000

Keywords: Effective Cost of Credit, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

51) The Boyles Ceramics, Inc. established a line of credit with a local bank. The maximum amount that

can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A

compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement,

Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay

off a note that was due. Boyles decides to borrow an amount sufficient to pay the $240,000 note and also

to cover the compensating balance. What is the effective annual cost of credit if the loan is made on a

discount basis?

A) 11.94%

B) 11.00%

C) 10.83%

D) 10.57%

Keywords: Effective Cost of Credit, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking