Principles of Managerial Finance, 15e (Zutter)
Chapter 16 Current Liabilities Management
16.1 Spontaneous liabilities
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 spontaneous liabilities that provide 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%
35) If a firm stretches its accounts payable, its cost of giving up a cash discount is increased.
36) Accruals are liabilities for services received for which payment has yet to be made.
37) It would be a financially sound decision to pay employees once every two weeks rather than once a
month.
38) 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%
39) 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
40) 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
41) ________ are liabilities for services received for which payment has yet to be made.
A) Notes payable
B) Accruals
C) Accounts payable
D) Accounts receivable
42) 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
16.2 Unsecured 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) A 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) The higher the riskiness of a borrower, the 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.
28) Tangshan Mining borrowed $10,000 for one year under a line of credit with a stated interest rate of 8
percent and a 10 percent compensating balance. Thus, the firm keeps a balance of about $800 in its
checking account.
29) Revolving credit agreements are guaranteed loans that specify the maximum amount that a firm can
owe the bank at any point in time.
30) Revolving credit agreements are non-guaranteed loans that specify the minimum amount that a firm
can owe the bank at any point in time.
31) A commitment fee is the fee that is normally charged on a revolving credit agreement.
32) Because the bank guarantees the availability of funds, a commitment fee is normally charged on a
simple line of credit agreement.
33) Cull Incorporated recently borrowed $250,000 from Century Bank when the prime rate was 4%. The
loan was for 90 days with interest to be paid at the end of the period with a rate fixed at 1.5% above the
prime rate. What is the total interest paid on this loan and what is the effective annual rate? (Assume a
365 day year.)
A) The total interest paid is $3390.41 and the effective annual rate is 5.62%.
B) The total interest paid is $13,750 and the effective annual rate is 5.62%.
C) The total interest paid is $13,750 and the effective annual rate is 5.55%.
D) The total interest paid is $3390.41 and the effective annual rate is 1.36%.
34) The major type of loan made by banks to businesses is the ________.
A) fixed-asset-based loan
B) short-term secured loan
C) short-term, self-liquidating loan
D) capital improvement loan
35) Short-term loans that businesses obtain from banks and through commercial paper are ________.
A) negotiated and secured
B) negotiated and unsecured
C) spontaneous and secured
D) spontaneous and unsecured
36) Short-term, self-liquidating loans are intended to ________.
A) provide one-time loan to the borrower who needs funds for a specific purpose
B) cover seasonal peaks in financing caused by inventory and receivable buildups
C) provide maximum amount to the firm that it can owe to the bank
D) recapitalize the firm
37) A loan that is usually a one-time loan made to a borrower who needs funds for a specific purpose for
a short period is called a ________.
A) term loan
B) bill of exchange
C) mortgage loan
D) single-payment note
38) The ________ is a rate of interest charged on business loans by the nation’s leading banks to
creditworthy business borrowers.
A) prime rate
B) commercial paper rate
C) federal funds rate
D) treasury bill rate
39) A single-payment note generally has a maturity of ________.
A) 30 days to 9 months or more
B) 10 to 12 months or more
C) 12 to 24 months or more
D) 10 to 24 months or more
40) Which of the following are the three basic ways of lending unsecured, short-term funds by
commercial banks?
A) mortgage-backed securities, T-bonds, and commercial paper
B) single-payment note, lines of credit, and revolving credit agreements
C) T-bills, municipal bonds, and commercial paper
D) commercial paper, real estate bonds, and corporate bonds
41) In a line of credit arrangement, a firm pays interest on ________.
A) the full line of credit
B) the total line of credit
C) only the amount actually borrowed
D) only the amount actually borrowed and commitment fees on any unused portion of the loan
42) Loans on which the interest is paid in advance are often called ________.
A) premium loans
B) long-term loans
C) term deposits
D) discount loans