Chapter 17—MANAGEMENT OF CURRENT LIABILITIES
MULTIPLE CHOICE
1. Which of the following factors influence the interest cost of a loan?
a.
the size of the loan
b.
existence of compensating balances
c.
loan discounting
d.
All of these answers are correct.
2. With a variable interest rate term loan, the interest rate is normally linked to the ____.
a.
Treasury bill rate
b.
long-term government bond rate
c.
prime rate
d.
Fed funds rate
3. The primary sources of spontaneous short-term credit for a firm include
a.
trade credit
b.
bank loans
c.
line of credit
d.
trade credit and bank loans
4. A floating lien is a loan in which the lender receives a security interest or general claim on all of a
company’s ____.
a.
fixed assets
b.
assets
c.
cash
d.
inventory
5. When receivables are ____, they no longer appear on the firm’s balance sheet.
a.
factored
b.
pledged
c.
factored and pledged
d.
disclosed
6. Firms generally prefer to borrow funds on an unsecured basis because pledging assets as security
a.
can raise the cost of the loan
b.
can reduce its future dividend payments
c.
can restrict its future sales of new equity
d.
can lower the cost of the loan
7. The most important source of short-term credit to business firms in the aggregate is
a.
bank loans
b.
trade credit
c.
receivables loans
d.
inventory loans
8. Paying trade credit beyond the end of the credit period is known as
a.
playing the float
b.
seasonal datings
c.
stretching payables
d.
stretching receivables
9. Accrued expenses
a.
are liabilities for services rendered to the firm that have not yet been paid by the firm
b.
are payments received for goods and services which are to be delivered by the firm at
some future date
c.
are shown on the firm’s balance sheet as an asset
d.
do not constitute an interest-free source of financing
10. Accrued expenses
a.
are an interest-free source of funds to the firm
b.
increase the firm’s liquidity and assets
c.
are listed as an asset on the firm’s balance sheet
d.
are liabilities for services that have already been paid by the firm
11. Deferred income
a.
is payments received for goods and services that are to be delivered by the firm at some
future date
b.
is a liability for services rendered to the firm which have not been paid by the firm
c.
increases the firm’s liquidity and assets
d.
increases the firm’s liquidity and assets and consists of payments received for goods and
services that are to be delivered by the firm at some future date
12. Deferred income
a.
represents a source of funds to the firm
b.
decreases the firm’s liquidity and assets
c.
is listed as an asset on the firm’s balance sheet
d.
consists of payments earned before delivery of goods or services
13. The primary source of deferred income to the firm is
a.
money owed to employees for their services
b.
funds owed to governments for taxes
c.
interest payments owed to banks
d.
advance payments made by customers
14. The prime rate is the:
a.
interest rate charged on loans to commercial banks by the Federal Reserve
b.
lowest published rate that large banks charge on loans made to their most credit-worthy
business customers
c.
interest rate on prime commercial paper
d.
prevailing interest rate on Treasury Bills
15. Which of the following provisions is usually not associated with a line of credit agreement?
a.
restrictions on the firm’s dividend payments
b.
commitment fee
c.
maintenance of a minimum working capital position
d.
commitment fees and restrictions on dividend payments
16. Which of the following statements concerning the pledging of receivables is(are) true?
a.
When accounts receivables are pledged, the firm retains title to the receivables.
b.
Most pledging is done on a non-recourse basis wherein the lender assumes the risk of
default on the pledged receivables.
c.
The firm is normally required to sign a promissory note and security agreement before
receiving the funds from the lender.
d.
a and c
17. Which of the following statements concerning factoring is true?
a.
Most factoring is done on a non-recourse basis
b.
When receivables are factored, the firm retains the title to the receivables
c.
The factor usually is not responsible for credit checking and collection of the receivables
d.
The use of factoring is confined to the apparel, furniture, and textile industries.
18. The net cost of borrowing under a non-recourse factoring arrangement will usually be below the stated
factoring cost and interest expenses because
a.
credit department cost can be reduced or eliminated
b.
bad-debt losses are eliminated
c.
interest rates charged by factors are generally below the prime rate charged by banks
d.
bad debt losses are eliminated, and credit department cost can be reduced or eliminated
19. “Floor Planning” is an example of a ____ inventory financing arrangement.
a.
floating lien
b.
trust receipt
c.
terminal warehouse
d.
field warehouse
20. Under a ____ financing agreement, the inventory that is being used as collateral for a loan is stored in
a bonded warehouse operated by a public warehousing company.
a.
floating lien
b.
trust receipts
c.
terminal warehouse
d.
field warehouse
21. Compensating balances are often required by financial institutions in a loan agreement in order to
a.
increase the return earned by the institution on the loan
b.
provide some measure of protection in the event of a default by the borrower
c.
both a and b
d.
none of the above
22. All of the following are legitimate forms of secured short-term financing except
a.
factoring accounts receivable
b.
terminal warehousing arrangements
c.
floating liens
d.
accrued expenses
23. Two loans involve the same principal amount, maturity, and nominal interest rates. One is a bullet
loan, the other a discounted loan. The effective annual percentage cost of the loan will be higher for
a.
the discounted loan
b.
the bullet loan
c.
the effective costs are the same
d.
not enough information is provided to answer the question
24. Open trade credit appears on the buyer’s balance sheet as
a.
accounts receivable
b.
accounts payable
c.
accruals
d.
trade credit
25. A major purpose of short-term bank loans is to
a.
meet the firm’s seasonal needs for funds
b.
purchase equipment
c.
provide start-up capital
d.
meet payroll expenses
26. Which of the following are potential purchasers of commercial paper?
a.
money market mutual funds
b.
insurance companies
c.
banks
d.
all the above are potential purchasers
27. Which of the following is not a characteristic of commercial paper?
a.
interest rates tend to be just a little over the prime lending rate
b.
sold on a discount basis
c.
has maturities ranging from a few days to a maximum of 9 months
d.
usually sold in multiples of $100,000
28. Under a field warehouse financing agreement, the inventory that serves as collateral for a loan is
a.
held in trust for the lender
b.
stored in a bonded warehouse
c.
all of the firm’s inventory
d.
segregated from the firm’s other inventory
29. All the following are advantages of accounts receivable loans except
a.
they are relatively liquid
b.
they involve documents representing customer obligations
c.
administrative costs of processing receivables are low
d.
their value is relatively easy to recover
30. Which of the following methods of financing would usually have the lowest cost to the firm?
a.
pledging accounts receivable
b.
commercial paper
c.
factoring accounts receivable
d.
line of credit
31. The factoring of receivables
a.
typically is done on a recourse basis
b.
typically is done on a non-notification basis
c.
removes the receivables from the factoring firm’s balance sheet
d.
does not affect the firm’s balance sheet
32. The pledging of receivables
a.
typically is done on a non-recourse basis
b.
typically is done on a non-notification basis
c.
by small companies generally is considered an indication of poor financial health
d.
is never done on a non-notification basis
33. A ____ is an agreement that permits a firm to borrow funds up to a predetermined limit at any time
during the life of the agreement.
a.
floating lien
b.
revolving lien agreement
c.
terminal loan
d.
line of credit
34. In a ____ the bank is legally committed to making loans to a company up to a predetermined credit
limit specified in the agreement.
a.
line of credit
b.
floating lien
c.
revolving credit agreement
d.
terminal loan
35. Idaho Industries currently purchases an average of $20,000 per day of raw materials. Idaho’s suppliers
offer credit terms of “net 60” and the firm waits until the end of the credit period to pay suppliers.
Determine Idaho Industries’ current level of trade credit (accounts payable).
a.
$ 20,000
b.
$600,000
c.
$1,200,000
d.
$200,000
36. Idaho Industries currently purchases an average of $20,000 per day of raw materials. Idaho’s suppliers
offer credit terms of “net 60” and the firm waits until the end of the credit period to pay its suppliers.
Determine the additional trade credit that can be obtained by the firm if Idaho stretches its accounts
payable an extra 30 days beyond the due date.
a.
$1,800,000
b.
$600,000
c.
$60,000
d.
$180,000
37. Determine the annual financing cost of foregoing a cash discount under credit terms of 2/30, net 90.
a.
8.0%
b.
24.0%
c.
12.2%
d.
12.4%
38. Melody Dairy has a line of credit with its bank. The firm plans to borrow $400,000 at a rate of 10
percent. The bank requires a 15 percent compensating balance and the firm currently maintains
$20,000 in its account at the bank that can be used to meet the compensating balance requirement.
Determine the annual financing cost to Melody of this loan.
a.
11.1%
b.
10.0%
c.
11.8%
d.
6.4%
39. Gooden Foods, Inc. has a revolving credit agreement with its bank under which it can borrow up to
$10 million at an annual interest rate of 12 percent. The firm is required to maintain a 10 percent
compensating balance on any funds borrowed under this agreement and to pay a 0.5 percent
commitment fee on the unused portion of the credit line. Determine the annual financing cost to
Gooden Foods of borrowing $4 million.
a.
13.3%
b.
14.7%
c.
14.2%
d.
2.7%
40. Northwest Container Company is considering selling an issue of commercial paper to finance its
seasonal needs. A commercial paper dealer has offered to sell a $10 million issue maturing in 90 days
at an interest rate of 10 percent per annum (deducted in advance). The dealer’s fee for selling the
commercial paper would be $10,000. Determine the annual financing cost of commercial paper
financing to Northwest.
a.
10.7%
b.
10.3%
c.
10.0%
d.
9.3%
41. What is the annual financing cost of a 1-year (365 day), $120,000 discounted bank loan at a stated
annual interest rate of 10.25 percent?
a.
11.42%
b.
11.64%
c.
10.25%
d.
8.76%
42. Syntech is offered credit terms of 2/10, net 40, but decides to forego taking the cash discount and pays
on the 45th day. What is Syntech’s cost of foregoing the cash discount?
a.
24.83%
b.
21.28%
c.
18.62%
d.
8.13%
43. Gamma Fax received a 90-day, $100,000 discounted loan at a stated annual rate of 10.5 percent. What
is the annual financing cost of this loan?
a.
10.78%
b.
10.50%
c.
10.94%
d.
4.08%
44. Calculate the annual financing cost, AFC, for a 91-day, $10,000 loan that has $400 of interest. The
entire principal amount is paid back at maturity. Assume 365 days per year.
a.
about 4 percent
b.
about 8 percent
c.
about 16 percent
d.
about 14 percent
45. Calculate the annual financing cost of foregoing the cash discount if the credit terms are 1/10, net 40.
a.
6.0 percent
b.
9.2 percent
c.
15.3 percent
d.
12.3 percent
46. Calculate the annual percentage rate of foregoing the cash discount if the credit terms are 1/10, net 40.
a.
1.13 percent
b.
13.0 percent
c.
20.1 percent
d.
11.11 percent
47. Wellington Industries currently purchases an average of $50,000 per day of raw materials from its
suppliers on terms of “net 45”. The company waits until the end of the credit period to pay its
suppliers. If Wellington stretches its accounts payable an extra 10 days beyond the due date and
increases its purchases to $60,000 per day next year, determine the amount of additional trade credit
these actions will generate.
a.
$600,000
b.
$1,050,000
c.
$3, 300,000
d.
cannot be determined from the information given
48. Determine the annual financing cost of foregoing a cash discount under credit terms of 3/10, net 4
months. Assume 30 days per month and 365 days per year.
a.
10.3%
b.
9.1%
c.
3.1%
d.
30%
49. Stephens Metals Company has a revolving credit agreement with its bank permitting it to borrow up to
$25 million at an annual interest rate of 12%. Stephens is required to maintain a 10% compensating
balance on any funds borrowed under this agreement and to pay a 0.5% commitment fee on the unused
portion of the credit line. The company maintains a $500,000 balance at the bank that can be used to
meet the compensating balance requirement. Determine the annual financing cost of borrowing $20
million under this revolving credit agreement.
a.
13.3%
b.
13.5%
c.
13.1%
d.
12.0%
50. Doyle Knitting Mills, Ltd. is considering factoring its receivables. The firm has annual sales of
$21,600,000. Its average collection period is 72 days. Bad-debt losses average 1.5 percent of sales and
credit department costs are $12,000 per month. Both of these costs would be eliminated if Doyle
factors its receivables. The factor will charge a fee of 3 percent on all receivables it purchases from
Doyle. The factor will advance up to 85 percent (i.e., 15% reserve for returns and allowances) of the
value of the receivables at an annual interest rate of 12 percent. Interest is deducted from the amount of
the advance. When converting from annual to daily data or vice versa, assume that there are 365 days
per year. Determine the amount of funds Doyle can obtain by factoring its receivables.
a.
$15,120,000
b.
$ 3,411,170
c.
$ 4,260,822
d.
$127,825
51. Doyle Knitting Mills, Ltd. is considering factoring its receivables. The firm has annual sales of $21.6
million. Its average collection period is 72 days. Bad-debt losses average 1.5 percent of sales and
credit department costs are $12,000 per month. Both of these costs would be eliminated if Doyle
factors its receivables. The factor will charge a fee of 3 percent on all receivables it purchases from
Doyle. The factor will advance up to 85 percent (i.e., 15 % reserve for returns and allowances) of the
value of the receivables at an annual interest rate of 12 percent. Interest is deducted from the amount of
the advance. When converting from annual to daily data or vice versa, assume that there are 365 days
per year. Determine the net annual financing cost (in $) to Doyle of factoring its receivables and
borrowing under this agreement.
a.
$ 175,656
b.
$ 210,529
c.
$ 599,265
d.
$324,000
52. Doyle Knitting Mills, Ltd. is considering factoring its receivables. The firm has annual sales of $21.6
million and its average collection period is 72 days. Bad-debt losses average 1.5 percent of sales and
credit department costs are $12,000 per month. Both of these costs would be eliminated if Doyle
factors its receivables. The factor will charge a fee of 3 percent on all receivables it purchases from
Doyle. The factor will advance up to 85 percent (i.e., 15 percent reserve for returns and allowances) of
the value of the receivables at an annual interest rate of 12 percent. Interest is deducted from the
amount of the advance. When converting from annual to daily data or vice versa, assume there are 365
days per year. Determine the net annual percentage financing cost of this factoring (and borrowing)
arrangement.
a.
17.6%
b.
14.8%
c.
7.1%
d.
22.4%
53. The Wham-O Company has a line of credit with a bank under which it can borrow up to $200,000 at
11 percent interest rate but it must maintain a 15 percent compensating balance on the borrowed
amount. If the firm currently maintains $10,000 in its account at the bank, what is the annual financing
cost of borrowing $150,000 for 90 days? Assume a 365 day year.
a.
12.94%
b.
12.0%
c.
12.17%
d.
15.4%
54. A commercial dealer has told Waltham Acceptance Corporation (WAC) that it can sell a $10 million
issue for WAC that will mature in 120 days. What is the annual financing cost of this issue if the
interest rate is 9.12 percent and the dealers fee is $12,500?
a.
9.99%
b.
9.40%
c.
9.74%
d.
9.81%
55. Pressing Club Corporation can raise needed short-term funds by pledging its receivables. First Bank
will lend Pressing 70 percent of the $2.5 million in pledged receivables at 11.2 percent plus a service
fee that equals 0.75 percent of the amount of the pledged receivables. Interest is computed based on
the amount of receivables pledged. If Pressing’s average collection period is 55 days, what is the
annual financing cost for the pledged receivables?
a.
2.7%
b.
18.3%
c.
23.1%
d.
11.2%
56. Hoffman Industries has negotiated a revolving credit agreement with its bank. The bank will loan
Hoffman up to $300,000 at an annual interest rate of 10% and requires a 0.3% commitment fee on the
unused portion of the credit agreement. The bank’s standard policy requires all loan customers to
maintain a 10% compensating balance on any amount borrowed. Hoffman currently maintains an
average balance of $8,000 that can be used to meet any compensating balance requirements. Compute
the annual financing cost of the revolving credit agreement, if the firm borrows an average of
$180,000 throughout the year.
a.
10.80 percent
b.
10.20 percent
c.
12.71 percent
d.
2.0 percent
57. Modern Textiles, Inc. is considering factoring its receivables. The firm has annual sales of $109.5
million. Its average collection period is 73 days. Bad-debt losses average 2% of sales and credit
department costs are $360,000 per year. Both of these costs would be eliminated if Modern Textiles
factors its receivables. The factor will charge a fee of 3.5% on all receivables it purchases from the
company. The factor will advance up to 80% of the value of the receivables at an annual interest rate
of 12%. Interest is deducted from the amount of the advance. Determine the annual financing cost to
Modern Textiles of factoring its receivables and borrowing under this arrangement. Assume 365 days
in any calculations.
a.
22.3%
b.
20.1%
c.
13.5%
d.
cannot be determined from the information provided
58. Indurain has a revolving credit agreement with its bank under which the firm can borrow up to
$750,000 at an interest rate of 2 percent over the prime rate. Currently the prime rate is 9.5%. Indurain
is required to keep a 10% compensating balance on any borrowed funds and to pay a 0.50% per year
commitment fee on the unused portion of the credit line. Indurain currently maintains a checking
balance of $30,000. What is the annual financing cost to borrow $500,000 for 180 days if no additional
funds are borrowed the remainder of the year?
a.
12.24%
b.
13.04%
c.
12.50%
d.
12.78%
59. The ALLTEL Company is considering the use of the commercial paper as a source of short-term
funds. A commercial paper dealer has told ALLTEL that it can sell a $20 million issue that will mature
in 270 days. The dealer’s fee will be $37,500 and the interest rate on the commercial paper will be 9.35
percent. What is the annual financing cost of this issue?
a.
9.60%
b.
7.63%
c.
10.34%
d.
9.54%
60. RoTech Medical Corp. needs to borrow $15 million dollars for 270 days. It can borrow from its bank
at its current interest rate of 9.75% plus a requirement to keep a 10% compensating balance. RoTech
currently has a $400,000 balance with its bank. An alternative for RoTech is to sell commercial paper.
The interest rate on the paper is 9.55% and the dealer’s fee for selling the paper is $22,500. Which
source has the least cost?
a.
Bank loan: 10.02% vs. 10.49% for paper
b.
Bank loan: 10.02% vs. 10.75% for paper
c.
Commercial paper: 9.70% vs. 10.02% bank
d.
Commercial paper: 10.49% vs. 10.52% bank
61. Ikon obtained a loan for $50,000. If loan requires a repayment of $51,000 in 91 days, what is the loan’s
APR?
a.
8.0%
b.
8.48%
c.
8.27%
d.
8.19%
62. Reingold obtained a 181-day loan for $225,000. If the loan requires an interest payment of $9,000,
what is the loan’s APR?
a.
8.23%
b.
8.58%
c.
8.16%
d.
8.51%
63. Smurfit issued $25 million of commercial paper with 270 days to maturity and an annual interest rate
of 8.32%. If the placement fee is $50,000, what is the annual financing cost to Smurfit?
a.
8.32%
b.
9.17%
c.
8.88%
d.
9.15%
ESSAY
1. What is commercial paper and what are the advantages and disadvantages of using it?
2. What is trade credit and why is it considered a spontaneous source of financing?