Principles of Managerial Finance, Brief, 7e (Gitman)
Chapter 15 Current Liabilities Management
15.1 Review accounts payable, the key components of credit terms, and the procedures for
analyzing those terms.
1) Spontaneous unsecured financing has a specific interest cost associated with it that can be at a
fixed or floating rate.
2) Accounts payable are spontaneous secured sources of short-term financing that arise from the
normal operations of a firm.
3) Notes payable are either spontaneous secured or spontaneous unsecured financing and result
from the normal operations of a firm.
4) Accounts payable results from transactions in which merchandise is purchased but no formal
note is signed to show the purchaser’s liability to the seller.
5) In credit terms, EOM (End-of-Month) indicates that the accounts payable must be paid by the
end of the month in which the merchandise has been purchased.
6) Spontaneous liabilities such as accounts payable and accruals represent a source of financing
that arise from the normal course of business.
7) The cost of giving up a cash discount is the implied rate of interest paid in order to delay
payment of an account payable for an additional number of days.
8) In giving up a cash discount, the amount of the discount that is given up is the interest being
paid by a firm to keep its money by delaying payment for a number of days.
9) A firm should take the cash discount if the firm’s cost of borrowing from the bank is greater
than the cost of giving up a cash discount.
10) If a firm anticipates stretching accounts payable, its cost of giving up a cash discount is
reduced.
11) For firms that are in a financial position to take a cash discount, it is advisable to take the
discount if the terms offered are 2/10 net 30.
12) Spontaneous liabilities such as accounts payable and notes payable represent a source of
financing that arise from the normal course of business.
13) Spontaneous liabilities such as accounts payable and accruals represent a use of financing
that arise from the normal course of business.
14) For firms that are in a financial position to take a cash discount, it is advisable not to take the
discount if the terms offered are 2/10 net 30.
15) As sales increase, a company needs more inventory and more employees resulting in
________.
A) more accounts payable and accruals, and therefore increasing its spontaneous liabilities
B) less accounts payable and accruals, and therefore decreasing its spontaneous liabilities
C) more accounts payable and accruals, and therefore decreasing its spontaneous liabilities
D) less accounts payable and accruals, and therefore increasing its spontaneous liabilities
16) The two major sources of short-term financing are ________.
A) a line of credit and notes payable
B) accounts payable and accruals
C) a line of credit and term loans
D) accounts receivable and notes payable
17) Accruals and accounts payable are ________.
A) negotiated and secured sources of long-term financing
B) negotiated and unsecured sources of short-term financing
C) secured sources of short-term financing
D) spontaneous and unsecured sources of short-term financing
18) 1/15 net 30 date of invoice translates as ________.
A) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the
balance is due in 30 days after the middle of the month
B) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the
balance is due 30 days after the invoice date
C) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the
balance is due 30 days after the end of the month
D) a 1 percent discount may be taken on 15 percent of the purchase if the account is paid within
30 days after the end of the month
19) 3/10 net 45 EOM translates as ________.
A) a 10 percent cash discount may be taken if paid in three days; if no cash discount is taken, the
balance is due in 45 days
B) a 3 percent cash discount may be taken if paid in 10 days; if no cash discount is taken, the
balance is due 45 days after transaction is complete
C) a 3 percent cash discount may be taken if paid in 10 days; if no cash discount is taken, the
balance is due 45 days after the end of the month
D) a 3 percent discount may be taken on 10 percent of the purchase if the account is paid within
45 days after the end of the month
20) One of the most common designations for the beginning of the credit period is ________.
A) 2/10
B) the date of invoice
C) the end of a quarter
D) the transaction date
21) If a firm decides to take the cash discount that is offered on goods purchased on credit, the
firm should ________.
A) pay as soon as possible
B) pay on the last day of the credit period
C) not take the discount no matter when the firm actually pays
D) pay on or before the last day of the discount period
22) The cost of giving up a cash discount on a credit purchase is ________.
A) added on to the price of the goods in order to make payment quickly
B) deducted from the price of the goods in order to make payment quickly
C) the implied interest rate paid in order to delay payment for an additional number of days
D) the true purchase price of the goods
23) A firm purchased goods with a purchase price of $1,000 and credit terms of 1/10 net 30. The
firm paid for these goods on the 5th day after the date of sale. The firm must pay ________ for
the goods.
A) $990
B) $900
C) $1,000
D) $1,100
24) A firm purchased goods on January 27 with a purchase price of $1,000 and credit terms of
2/10 net 30 EOM. The firm paid for these goods on February 9. The firm must pay ________ for
the goods.
A) $1,000
B) $980
C) $800
D) $900
25) If a firm gives up the cash discount on goods purchased on credit, the firm should pay the bill
________.
A) as per its will
B) on the last day of the discount date
C) after the credit period
D) on the last day of the credit period
26) A firm is offered credit terms of 2/10 net 45 by most of its suppliers but frequently does not
have the cash available to take the discount. The firm has a credit line available at a local bank at
an interest rate of 12 percent. The firm should ________.
A) give up the cash discount, financing the purchase with the line of credit
B) take the cash discount and pay on the 45th day after the date of sale
C) take the cash discount and pay on the first day of the cash discount period
D) take the cash discount, financing the purchase with the line of credit, the cheaper source of
funds
27) A firm is offered credit terms of 1/10 net 45 EOM by a major supplier. The firm has
determined that it can stretch the credit period (net period only) by 25 days without damaging its
credit standing with the supplier. Assuming the firm needs short-term financing and can borrow
from the bank on a line of credit at an interest rate of 14 percent, the firm should ________.
A) give up the cash discount and finance the purchase with the line of credit
B) give up the cash discount and pay on the 70th day after the date of sale
C) take the cash discount and pay on the first day of the cash discount period
D) take the cash discount and finance the purchase with the line of credit, the cheaper source of
funds
28) Tangshan Mining has extended credit terms of 3/15 net 30 EOM. The cost of giving up the
cash discount, assuming payment would be made on the last day of the credit period, is 75.26
percent. If the firm were able to stretch its accounts payable to 60 days without damaging its
credit rating, the cost of giving up the cash discount would only be ________.
A) 18.81%
B) 18.25%
C) 21.90%
D) 25.09%
29) ________ are the major source of unsecured short-term financing for business firms.
A) Accounts receivable
B) Term loans
C) Notes payable
D) Accounts payable
30) Credit terms 2/10, net 30 means ________.
A) a discount of 10% is granted if payments are done within 30 days
B) a discount of 10% is granted if payments are done within 2 days, net 30 days available
C) a discount of 2% is granted if payments are done within 10 days, net 30 days available
D) a discount of 2% is granted if payments are done within 30 days, beyond which a 10%
interest is charged
31) The cost of giving up a cash discount under the terms of sale 1/10 net 60 (assume a 360-day
year) is ________.
A) 7.3 percent
B) 6.1 percent
C) 14.7 percent
D) 12.2 percent
32) The cost of giving up a cash discount under the terms of sale 5/20 net 120 (assume a 360-day
year) is ________.
A) 15 percent
B) 18.9 percent
C) 15.8 percent
D) 20 percent
33) Ashley’s Delivery Service is analyzing the credit terms of each of three suppliers, A, B, and
C.
(a) Determine the approximate cost of giving up the cash discount (assume a 360-day year).
(b) Assuming the firm needs short-term financing, recommend whether or not the firm should
give up the cash discount or borrow from the bank at 10 percent annual interest. Evaluate each
supplier separately.
34) Tangshan Mining has extended credit terms of 3/15 net 30 EOM. The cost of giving up the
cash discount, assuming payment would be made on the last day of the credit period, would be
________.
A) 75.26%
B) 3.1%
C) 72.99%
D) 37.12%
15.2 Understand the effects of stretching accounts payable on their cost and the use of accruals.
1) If a firm stretches its accounts payable, its cost of giving up a cash discount is increased.
2) Accruals are liabilities for services received for which payment has yet to be made.
3) It would be a financially sound decision to pay employees once every two weeks rather than
once a month.
4) Tangshan Mining was extended credit terms of 3/15 net 30 EOM. The cost of giving up the
cash discount, assuming payment would be made on the last day of the credit period, would be
________. If the firm were able to stretch its accounts payable to 60 days without damaging its
credit rating, the cost of giving up the cash discount would only be ________.
A) 72.99%; 18.81%
B) 72.99%; 18.25%
C) 75.25%; 21.90%
D) 75.26%; 25.09%
5) When a firm stretches accounts payable without hurting its credit rating, the cost of giving up
a cash discount is ________.
A) reduced
B) increased
C) unaffected
D) increased or decreased depending on the opening accounts payable balance
6) As part of a union negotiation agreement, the United Clerical Workers Union conceded to be
paid every two weeks instead of every week. A major firm employing hundreds of clerical
workers had a weekly payroll of $1,000,000 and the cost of short-term funds was 12 percent. The
effect of this concession was to delay clearing time by one week. Due to the concession, the firm
________.
A) realized an annual loss of $120,000
B) realized an annual savings of $120,000
C) increased its cash cycle
D) decreased its cash turnover
7) ________ are liabilities for services received for which payment has yet to be made.
A) Notes payable
B) Accruals
C) Accounts payable
D) Accounts receivable
8) Jannet Company, currently pays its employees at the end of a week. The weekly payroll totals
$400,000. If it were to extend the pay period so as to pay its employees 1 week later throughout
an entire year, the employees would in effect be lending the firm ________ for a year.
A) $400,000
B) $20,800,000
C) $4,800,000
D) $675,000
15.3 Describe interest rates and the basic types of unsecured bank sources of short-term loans.
1) Unlike the spontaneous sources of unsecured short-term financing, bank loans are negotiated
and result from deliberate actions taken by the financial manager.
2) Self-liquidating loans are intended merely to carry a firm through seasonal peaks in financing
needs that are due primarily to buildups of accounts receivable and inventory.
3) Self-liquidating loans are mainly invested in productive assets (i.e., fixed assets) which
provide the mechanism through which the loan is repaid.
4) The major attraction of a line of credit from the bank’s point of view is that it eliminates the
need to examine the creditworthiness of a customer each time it borrows money within the year.
5) The interest rate on a line of credit is normally stated as a fixed rate-the prime rate.
6) A line of credit is an agreement between a commercial bank and a business, specifying the
amount of unsecured short-term borrowing the bank will make available to the firm over a given
period of time.
7) A revolving credit agreement is a form of financing consisting of short-term, unsecured
promissory notes issued by firms with a high credit standing.
8) Compensating balance is a checking account balance equal to a certain percentage of the
amount borrowed from a bank under a line-of-credit or revolving credit agreement.
9) The risk-free rate is the lowest rate of interest charged by the nation’s leading banks on
business loans to their most important and reliable business borrowers.
10) Operating change restrictions are contractual restrictions that a bank may impose on a firm as
part of a line of credit agreement.
11) The effective interest rate on a bank loan depends on whether interest is paid when the loan
matures or in advance.
12) The prime rate of interest fluctuates with changing supply-and-demand relationships for
short-term funds.
13) A discount loan is a loan on which interest is paid in advance by deducting it from the loan
so that the borrower actually receives less money than is requested.
14) A single-payment note is a secured fund which can be obtained from a commercial bank
when a borrower needs additional funds for a short period.
15) Under a line of credit agreement, a bank may retain the right to revoke the line if any major
changes occur in the firm’s financial condition or operations.
16) Under a line of credit agreement, a bank may require an annual cleanup, which means that
the borrower must pay off all its outstanding debts to all its operational creditors for a certain
number of days during the year.
17) Although more expensive than a line of credit, a revolving credit agreement can be less risky
from the borrower’s viewpoint.
18) An increment above the prime rate on a floating-rate loan will be higher than on a fixed-rate
loan of equivalent risk because the lender bears higher risk with a floating-rate loan.
19) A fixed-rate loan is a loan whose rate of interest is established at a fixed increment above the
prime rate and is allowed to vary above the prime rate only when the prime rate varies until
maturity.
20) The effective interest rate for a discount loan is greater than the loan’s stated interest rate.
21) A compensating balance is a balance in checking account that is equal to a certain percentage
of the borrower’s short-term unsecured loan.
22) Operating-change restrictions gives the bank a right to revoke the line of credit if any major
changes occur in a firm’s financial condition or operations.
23) If one borrows $1,000 at 8 percent interest on a discount basis, the effective rate of interest is
7.2 percent.
24) Higher the riskiness of a borrower, higher is the premium charged above the prime rate by a
banker.
25) Lines of credit are non-guaranteed loans that specify the maximum amount that a firm can
owe the bank at any point in time.
26) Lines of credit are guaranteed loans that specify the maximum amount that a firm can owe
the bank at any point in time.
27) A compensating balance not only forces the borrower to be a good customer of the bank but
may also raise the interest cost to the borrower.