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Chapter 16 – Managing Short-Term Liabilities (Financing)
1. If a firm is offered credit terms of 2/10, net 30, it is in the firm’s financial interest to pay as early during the discount
period as possible.
a. True
b. False
2. Trade credit can be separated into two components: free trade credit, which involves credit received after the
discount period ends, and costly trade credit, which is the cost of discounts not taken.
a. True
b. False
3. As a rule, managers should try to always use the free component of trade credit but should use the costly
component only after comparing its costs to the costs of similar credit from other sources.
a. True
b. False
4. Trade credit is an inexpensive source of short-term financing if no discounts are offered.
a. True
b. False
5. When deciding whether or not to take a trade discount, the cost of borrowing funds should be compared to the cost
of trade credit to determine if the cash discount should be taken.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
6. The calculated cost of trade credit is reduced by paying late.
a. True
b. False
7. The calculated cost of trade credit for a firm that buys on terms of 2/10, net 30, is lower (other things held constant)
if the firm pays in 40 days than if it pays in 30 days.
a. True
b. False
8. One of the disadvantages of not taking trade credit discounts when offered is that the firm’s investment in accounts
payable rises.
a. True
b. False
9. Trade credit and accrual accounts are always costless sources of spontaneous financing for the firm.
a. True
b. False
10. A firm is said to be extending net trade credit when its accounts receivable are less than its accounts payable.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
11. When a firm has accounts payable that are greater than the level of its receivables, the firm is actually receiving net
trade credit.
a. True
b. False
12. “Stretching” accounts payable is a widely accepted and costless financing technique.
a. True
b. False
13. Short–term financing might be riskier than long–term financing because, during periods of tight credit, the firm might
not be able to rollover (renew) its debt.
a. True
b. False
14. One of the advantages of short-term debt financing is that firms can expand or contract their short-term credit
more easily than their long-term credit.
a. True
b. False
15. Short-term loans generally are obtained faster than long–term loans because when lenders consider long-term loans
they insist on a more thorough evaluation of the borrower’s financial health and because the loan agreement is more
complex.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
16. A line of credit and a revolving credit agreement are similar except that a line of credit creates a legal obligation for
the bank.
a. True
b. False
17. A promissory note is the document signed when a bank loan is executed and it specifies financial aspects of the
loan. The separate indenture note will specify items such as collateral and other terms and conditions.
a. True
b. False
18. The maturity of most bank loans is short-term. Bank to business loans are frequently 90–day notes which are often
rolled over, or renewed, at the end of their maturity.
a. True
b. False
19. A line of credit can be either a formal or informal agreement between borrower and bank regarding the maximum
amount of credit the bank will extend to the borrower subject to certain conditions.
a. True
b. False
20. Under a revolving credit agreement the risk to the firm of being unable to obtain funds when needed is lower than
with a line of credit.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
21. Assume a firm takes out a discounted loan with its local bank. By the very nature of a discount loan, a
compensating balance requirement will exist, and this will lead to a higher effective rate on this loan versus the
loan’s simple, or stated, rate.
a. True
b. False
22. On a 1-year loan for $10,000, a firm would be better off borrowing at a rate of 9.5 percent discounted interest than
9 percent simple interest.
a. True
b. False
23. Many firms borrow by using banker’s acceptances (i.e., getting a bank to guarantee the firm’s debt) when they are
too small or too risky to use the commercial paper market.
a. True
b. False
24. The risk of default on pledged accounts receivable is borne by the lender to whom the receivables are pledged.
a. True
b. False
25. Factoring involves the outright sale of accounts receivable.
a. True
b. False
26. When a firm factors its accounts receivable, the factor normally performs the functions of risk bearing, credit
checking, and lending.
a. True
b. False
27. The pledging of receivables differs from factoring in that, under pledging, the lender normally has recourse against
the borrower.
a. True
b. False
28. Accounts receivable financing, especially the factoring of accounts, is a very flexible source of funds. Once the
factoring procedure has been established, funds from this type of financing will automatically increase as the firm
increases its sales.
a. True
b. False
29. Liabilities such as wages and taxes that increase spontaneously with operations are called accruals.
a. True
b. False
30. Trade credit is seldom used by firms and is an insignificant component of short–term debt for most firms.
a. True
b. False
31. A promissory note is a document specifying the terms and conditions of a loan, including the amount, interest rate,
and repayment schedule.
a. True
b. False
32. A compensating balance is an arrangement in which a bank agrees to lend up to a specified maximum amount of
funds during a designated period.
a. True
b. False
33. A commitment fee is a fee charged on unused balance of a revolving credit agreement to compensate the bank for
guaranteeing that the funds will be available when needed by the borrower.
a. True
b. False
34. A bank with fluctuating deposit liabilities in a static community will tend to follow creative banking practices when
approving loans.
a. True
b. False
35. Commercial paper is a type of secured promissory issued by large, strong financial firms.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
36. The factor (lender) purchasing accounts receivable from borrower has recourse against the borrower if the
accounts receivable cannot be collected.
a. True
b. False
37. The uniform commercial code is a system of standards that simplifies procedures for establishing loan security.
a. True
b. False
38. Long-term loan agreements always contain provisions, or covenants, which constrain the firm’s future actions.
Short-term credit agreements are just as restrictive in order to protect the interests of the lender.
a. True
b. False
39. A firm constructing a new manufacturing plant and financing it with short-term loans that are scheduled to be
converted to bonds when the plant is completed, would want to separate the construction loan from other current
liabilities associated with working capital management.
a. True
b. False
40. If a firm fails to take trade credit discounts it may cost the firm money, but generally such a policy has a negligible
effect on the firm’s income statement and no effect on the firm’s balance sheet.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
41. If a firm is involuntarily “stretching” its accounts payable then this is one sign that it is undercapitalized; that is, that
it needs more working capital for operations.
a. True
b. False
42. A firm that “stretches” its accounts payable rather than paying on net terms is actually increasing its calculated cost
of credit given that it already does not take discounts when offered, other things held constant.
a. True
b. False
43. If one of your firm’s customers is “stretching” its accounts payable, this may be a nuisance but does not represent a
real financial cost to your firm as long as the firm periodically pays off its entire balance.
a. True
b. False
44. The prime rate charged by big money center banks can vary greatly (for example, as much as 2 to 4 percentage
points) across banks due to banks’ ability to differentiate themselves and because particular banks develop
particular clienteles, such as mainly making loans to small firms.
a. True
b. False
45. A revolving credit agreement is a formal line of credit usually used by large firms. The firm will pay a fee on the
unused balance of the committed funds to compensate the bank for the commitment to extend those funds.
a. True
b. False
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Chapter 16 – Managing Short-Term Liabilities (Financing)
46. When a firm pledges its accounts receivable, if a customer that purchased goods from the firm does not pay, the
selling firm must take the loss.
a. True
b. False
47. Firms having difficulty borrowing short-term funds from banks can raise short-term funds by issuing commercial
paper.
a. True
b. False
48. Firms generally choose to finance temporary assets with short-term debt because
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates traditionally have been more stable than long-term interest rates.
c. A firm that borrows heavily long-term is more apt to be unable to repay the debt than the firm that borrows
heavily short-term.
d. The yield curve traditionally has been downward sloping.
e. Sales remain constant over the year, and financing requirements also remain constant.
49. Which of the following statements concerning commercial paper is false?
a. Commercial paper generally is written for terms less than 270 days.
b. Commercial paper generally carries an interest rate below the prime rate.
c. Commercial paper is sold to money market mutual funds, as well as to other financial institutions and
nonfinancial corporations.
d. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
50. Small, undercapitalized firms
a. Are generally users of net trade credit.
b. Are major users of banker’s acceptances.
c. Generally do not issue commercial paper.
d. Typically have a high cost of debt capital.
e. Are described by all of the above statements.
51. Inventory financing can take the form of a
a. Blanket lien.
b. Trust receipt.
c. Warehouse receipt.
d. All of the above.
e. Answers a and b above.
52. Which of the following is not a common type of short term financing?
a. Commercial paper.
b. Accruals.
c. Trade credit.
d. Corporate bonds.
e. Bank loans.
53. Accruals are generally considered debt since interest is paid on accruals.
a. adjustable rate; varying amounts of
b. expensive; high rates of
c. cheap; low rates of
d. free; no
e. fixed; a constant low rate of
54. Seagar Corporation provides monofilament fishing line to its customers. Seagar gives its customers a three percent
discount if the invoice payment is paid within 10 days of the billing date. If the discount is not taken then the balance
must paid in full within 45 days of the billing date. Any unpaid balances over 45 days beyond the billing date will be
assessed a five percent penalty every 30 days, beginning 46 days after the billing date. Seagar is said to sell on
credit with terms of what?
a. 5/30, net 45
b. 3/45, net 60
c. 3/10, net 45
d. 3/10, net 30
e. 5/10, net 30
55. Financial managers should always use the free component of the trade credit, but they should use the costly
component only after analyzing this source of financing to make sure
a. that it is greater than the cost of funds for the firm.
b. that it has a maturity less than the average collection period.
c. that it is less than the cost of funds for the firm.
d. that the default risk inherent in accepting this trade credit is low.
e. that firms offering the trade credit does not issue commercial paper.
56. Under the terms of trade found in most industries, the costly component of trade credit
a. is relatively cheap, thus financially strong firms forego the cash discount.
b. is relatively expensive, thus financially strong firms will take the cash discount.
c. is relatively expensive, thus financially strong firms forego the cash discount.
d. is relatively cheap, thus financially strong firms will take the cash discount.
e. is relatively cheap, thus most financially strong firms don’t consider the terms of trade.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
57. A document specifying the terms and conditions of a bank loan, including the amount, interest rate, repayment
schedule, and any other terms or conditions of the loan is a
a. compensating balance.
b. commitment fee.
c. commercial paper.
d. trade credit.
e. promissory note.
58. An arrangement in which a bank agrees to lend up to a specified maximum of funds as needed over a specified
time period is a
a. compensating balance.
b. line of credit.
c. commercial paper.
d. trade credit.
e. promissory note.
59. An important difference between revolving credit and a general line of credit is
a. that a bank has a legal obligation to honor a general line of credit.
b. that a bank receives a commitment fee for guaranteeing the funds under a general line of credit.
c. the commitment fees on a general line of credit are generally higher than the commitment fees on a revolving
line of credit.
d. that a bank has a legal obligation to honor a revolving line of credit.
e. that there are no differences between a general line of credit and a revolving line of credit.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
60. Which of the following aspects is not important to a business when choosing a bank?
a. Willingness to assume risk.
b. Advice and counsel.
c. Loyalty to customers.
d. Size of the bank.
e. All of the above are important to businesses when choosing a bank.
61. Which of the following is not one of primary purchasers of commercial paper?
a. Other businesses.
b. Insurance companies.
c. Pension funds.
d. Individual investors.
e. Banks.
62. A loan that is backed by collateral is a(n) loan.
a. senior
b. amortized
c. subordinate
d. commercial
e. secured
63. Which of the following functions does the factor (lender) purchasing accounts receivable normally perform?
a. Credit checking.
b. Lending.
c. Risk bearing.
d. All of the above.
e. None of the above.
64. The three main working capital strategies discussed in the text, aggressive, conservative, and moderate, differ
primarily in the
a. Relative amount of short-term debt used.
b. Minimum level of permanent current assets.
c. Relative amount of long–term debt versus equity used to finance permanent current assets.
d. Average level of temporary current assets.
e. Amount of trade credit used.
65. Which of the following statements is correct?
a. Under normal conditions, a firm’s expected ROE probably would be higher if it financed with short-term than
with long-term debt, but the use of short-term debt would probably increase the firm’s risk.
b. Conservative firms generally use no short-term debt and thus have zero current liabilities.
c. A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt
is likely to be higher than that of long-term debt.
d. If a firm that can borrow from its bank buys on terms of 2/10, net 30, and if it must pay by Day 30 or else be
cut off, then we would expect to see zero accounts payable on its balance sheet.
e. If one of your firm‘s customers is “stretching” its accounts payable, this may be a nuisance but does not
represent a real financial cost to your firm as long as the firm periodically pays off its entire balance.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
66. Which of the following statements is correct?
a. Under normal conditions the shape of the yield curve implies that the interest cost of short-term debt is greater
than that of long-term debt, although short-term debt has other advantages that make it desirable as a
financing source.
b. Flexibility is an advantage of short-term credit but this is somewhat offset by the higher flotation costs
associated with the need to repeatedly renew short-term credit.
c. A short-term loan usually can be obtained more quickly than a long-term loan but the penalty for early
repayment of a short-term loan is significantly higher than for a long-term loan.
d. Statements about the flexibility, cost, and riskiness of short-term versus long-term credit are dependent on
the type of credit that actually is used.
e. Short-term debt is often less costly than long-term debt and the major reason for this is that short-term debt
exposes the borrowing firm to much less risk than long-term debt.
67. Which one of the following aspects of banks is considered most relevant to businesses when choosing a bank?
a. Convenience of location.
b. Competitive cost of services provided.
c. Size of the bank‘s deposits.
d. Experience of personnel.
e. Loyalty and willingness to assume lending risks.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
68. Which of the following statements is correct?
a. In a factoring arrangement, the factor always performs three functions: (1) credit checking, (2) lending, and
(3) receivables collection.
b. The pledging of accounts receivable involves a transfer of the risk associated with accounts receivable from
the borrower to the lender.
c. In a factoring arrangement, the seller can select various combinations of credit checking, lending, and risk
bearing the factor performs by changing provisions in the factoring agreement.
d. In a factoring agreement, the factor would not perform the credit checking and risk taking functions without
performing the lending function, because the former are required before the factor can lend to the seller.
e. The financing of accounts receivable involves an agreement which is informal and non-binding, which makes
it difficult for the factor to protect itself.
69. Which of the following statements is correct?
a. The factoring of accounts receivable consists of a series of individual cycles as opposed to a continuous
process.
b. Once a factoring agreement is in force, funds from this source are spontaneous in the sense that an increase
in sales will automatically generate additional credit from the factor.
c. One of the main disadvantages of pledging or factoring is the significant lack of flexibility.
d. One disadvantage of factoring is that it reduces the need of the selling firm to maintain a credit department.
e. The cost of pledging and factoring generally is very low and the risk bearing fee is incorporated into the
interest rate charged on the unpaid balance of the funds advanced by the factor, which is usually one half of
one percent above the prime rate.
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Chapter 16 – Managing Short-Term Liabilities (Financing)
70. Which of the following statements is correct?
a. An inventory blanket lien gives the lending institution a lien against all of the borrower‘s inventories.
However, the borrower must maintain a base inventory as collateral equal to the level that existed when the
loan was granted.
b. A disadvantage of trust receipt financing is the requirement that a trust receipt be issued for specific goods.
As a result of this inconvenience, warehousing has become popular as a method of securing loans with
inventory.
c. The fixed costs of a field warehousing arrangement are relatively small and, thus, many small firms make
such arrangements.
d. The use of inventory financing, especially field warehouse financing, as a source of funds for firms has the
advantage of small fixed costs but the disadvantage of a lack of spontaneous growth of funds as inventories
increase.
71. All else equal, a firm that purchases raw materials on credit will have a(n)
in purchases.
a. decrease; no change
b. no change; decrease
c. increase; increase
d. increase; decrease
e. decrease; increase
in trade credit with a given
72. Which of the following economic conditions are banks likely to lower the interest rates charge on loans of all types?
a. The Fed restricting the money supply.
b. Strong demand for bank loans.
c. Lower inflation.
d. Answers a and b.
e. None of the above.
73. Most secured short-term business borrowings involves the use of as collateral.
a. real estate
b. marketable securities
c. equipment
d. inventory
e. None of the above.
74. A firm is offered trade credit terms of 3/15, net 45. The firm does not take the discount, and it pays after 67 days.
What is the approximate annual cost of not taking the discount?
a. 21.41%
b. 22.07%
c. 22.95%
d. 23.48%
e. 24.52%
75. Dixie Tours Inc. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 35 days after the
invoice date. Net purchases amount to $720,000 per year. What is the approximate percentage cost of its non-free
trade credit?
a. 17.2%
b. 23.6%
c. 26.1%
d. 36.7%
e. 50.6%