18) U.S. Treasury Bills are extremely liquid due to excellent secondary markets.
19) Commercial paper is much more liquid than money-market mutual funds because
commercial paper is available to only the most creditworthy corporations.
20) U.S. Treasury Bills, bankers’ acceptances and commercial paper are all sold on a discount
basis.
21) Compare the risk of a 90-day unsecured promissory note issued by Southwest Airlines to a
20-year U.S. Government Treasury Bond.
A) The Treasury Bond has a lower financial risk, but a higher interest rate risk.
B) The Treasury Bond has a lower financial risk and a lower interest rate risk.
C) The Treasury Bond has a lower interest rate risk, but higher financial risk.
D) The Treasury Bond has a higher interest rate risk, and a higher financial risk.
22) Which of the following has the highest interest rate risk?
A) a 20-year U.S. Treasury Bond
B) Bendix Corporation six-month commercial paper
C) a six-month money market certificate at a federally issued bank
D) a Southwest Airlines bond maturing in four years
23) Which of the following has the least interest rate risk?
A) a six-month unsecured promissory note from International Harvester
B) an eight-year investment certificate from a federally insured bank
C) a 15-year U.S. Treasury bond
D) an AT&T bond maturing in 15 years
24) If you compare the yield of a municipal bond with that of a negotiable certificate of deposit,
what is the equivalent before-tax yield of the certificate of deposit if the municipal bond has a
yield of 8% per year and the investor has a marginal tax rate of 28%?
A) 8.28%
B) 9.30%
C) 10.24%
D) 11.11%
25) Which of the following are short-term, unsecured promissory notes sold by large businesses?
A) negotiable certificates of deposit
B) repurchase agreements
C) money market mutual funds
D) commercial paper
26) Which of the following is the least liquid?
A) U.S. Treasury bills
B) commercial paper
C) money market mutual funds
D) federal agency securities
27) The financial manager is concerned with
A) striking a balance between holding too much and too little cash.
B) maintaining high levels of profitability.
C) minimizing the chance of insolvency.
D) all of the above.
28) Banker’s acceptances have the following characteristics except:
A) typically maturities of 1 to 5 years.
B) fully taxable at the federal, state, and local levels.
C) are sold on a discount basis and payable to the bearer.
D) are not “issued” in predetermined denominations.
29) If you were a treasurer for a Fortune 1,000 corporation who has responsibility for investing
“excess cash balances,” which of the following alternatives would you be least likely to select?
A) commercial paper
B) common stock
C) bankers’ acceptances
D) U.S. Treasury bills
30) ________ is a short-term promissory note sold by large corporations to raise cash.
A) Repurchase agreement
B) Money market mutual fund
C) Commercial paper
D) U.S. Treasury bills
31) Considerations in the selection of a proper marketable-securities mix include all of the
following except:
A) financial risk.
B) interest rate risk.
C) maturity.
D) liquidity.
32) You have a choice between investing in a corporate bond or a municipal bond. The corporate
bond has an annual yield of 10 percent, while the municipal bond has an annual yield of 7
percent. At what tax rate would you be indifferent between buying the corporate bond or the
municipal bond?
33) The corporate treasurer of Wooden Furniture Inc. is considering the purchase of either a
municipal obligation with a 6.1% coupon or a corporate bond with a 9.5% return. Both bonds
have a $1,000 par value. The company is currently in the 35% marginal tax bracket. Which
security should the treasurer recommend?
34) The selection of a proper marketable-securities mix involves evaluation of certain criteria.
What are these criteria and why are they important?
16.5 Learning Objective 5
1) Accounts receivable is an asset representing sales made on credit.
2) For many industries accounts receivable comprise as much as 25 percent of total assets.
3) Accounts receivable variables under control of the financial manager include the terms of
credit sales and the quality of credit customers.
4) The financial manager typically cannot control the level of credit sales, and hence the
company’s investment in accounts receivable, as the level of credit sales is determined in large
part by the nature of the business enterprise.
5) Terms of sale are frequently changed by the financial manager in order to increase sales.
6) One method used to monitor the collections of accounts receivable is aging.
7) Efficient collection of accounts receivable helps to determine both the profitability and the
liquidity of the firm.
8) In terms of trade credit, default costs vary indirectly with the quality of the customer.
9) The decision to forgo the discount available to those customers who pay early has an
advantage as well as a disadvantage.
10) According to the Altman model, multiple discriminant analysis indicates that those
applicants with a Z score below 2.7 have a significant probability of filing for bankruptcy within
a year.
11) A company’s investment in accounts receivable is determined by the company’s level of
sales, percent of credit sales to total sales, and credit and collection policies.
12) The speed of the collections process is determined by three types of float: mail float,
processing float, and transit float.
13) Current assets in order of liquidity are cash, marketable securities, inventory, and accounts
receivable.
14) The terms of sale identify the possible discount for early payment, the discount period, and
the total credit period.
15) A corporation that is short on cash will take a trade discount of 2/10 net 30 only if the
corporation’s cost of funds is less than 2%.
16) Total float consists of each of the following elements except:
A) mail float.
B) processing float.
C) transit float.
D) audit float.
17) A retailer sells most of its merchandise on credit and bills clients monthly. Which of the
following elements of float does the retailer have the most control over?
A) mail float
B) processing float
C) transit float
D) disbursing float
18) A large corporation has annual sales revenues of $6 billion. The corporation currently earns
2.25% on its money market account. If the corporation can reduce its float by one day by
making its billing and collection functions more efficient, the company’s operating profits will
increase by approximately
A) $369,863
B) $296,500
C) $135,000
D) $36,986
19) Given that short-term interest rates typically fluctuate less than long-term rates, interest rate
risk is least for
A) treasury bills.
B) common stock.
C) long-term government bonds.
D) medium-term corporate bonds.
20) Money market funds
A) are tax exempt.
B) typically invest in a diversified portfolio of short-term, high-grade debt instruments.
C) are generally very profitable but fail to provide liquidity to the small investor.
D) typically sell shares to the public in $25,000 denominations.
21) A firm’s credit and collection policies usually include
A) terms of sale, quality of customers, and collection of credit sales.
B) average collection period, dollar value of aged receivables, and terms of sale.
C) terms of sale and collection of credit sales.
D) terms of sale, level of credit sales, and collection of credit sales.
22) An aging schedule of accounts receivable aids the financial manager in determining
A) the amount of receivables that are past due.
B) the average age of the customers.
C) the receivables turnover.
D) the average length of the discount period.
23) A trade credit discount such as 3/10 net 40 means
A) a 3 percent penalty is due after 40 days.
B) a 3 percent discount if payment is made within 10 days, otherwise, the total amount is due in
40 days.
C) a 3 percent discount for payment within 10 days, and a 3 percent penalty if payment is made
after 40 days.
D) 10 percent discount for cash on delivery and a 3 percent discount for payment within 40 days.
24) If a firm with credit terms of 1/10 net 30 were to change its terms to 3/10 net 30, the result
would probably be
A) increased bank loans.
B) increased accounts receivable turnover.
C) an increase in the average level of accounts receivable.
D) a decrease in accounts payable.
25) If a firm with credit terms of 2/10 net 30 were to change its terms to 2/10 net 60, the result
would probably be
A) more customers would take advantage of the cash discount.
B) fewer customers would take advantage of the cash discount.
C) increased accounts receivable turnover.
D) a reduction in safety stock.
26) Determine the effective annualized cost of forgoing the trade discount on terms 2/15 net 65.
A) 11.30%
B) 14.69%
C) 32.6%
D) 48.98%
27) Determine the effective annualized cost of forgoing the trade discount on terms 1/20 net 45.
A) 14.55%
B) 15.24%
C) 16.780%
D) 20.69%
28) Which of the following is generally under the control of the financial manager?
A) the percentage of credit sales to total sales
B) the actual level of sales
C) the credit policies
D) A and B
29) Credit and collection policies affect all of the following except:
A) level of sales.
B) length of time before credit sales are collected.
C) terms of sales.
D) pricing policies.
30) Which of the following might occur when a firm increases its collection efforts:
A) an increase in inventory costs.
B) an increase in bad debts.
C) an increase in sales.
D) a decline in accounts payable.
31) Which of the following factors determines the amount that a firm would have invested in
accounts receivable?
A) collection efforts
B) the percentage of credit sales to total sales
C) the volume of sales
D) the terms of sale
E) All of the above.
32) If a firm extends 4/10, net 60-day terms of sale, what is the cost in terms of nominal APR?
Assume a 360-day year.
A) 29.40%
B) 30.0%
C) 23.99%
D) 27.86%
33) You purchase $10,000 worth of supplies every 90 days and never take the trade discount of
2/10 net 30. How much could you save each (360-day) year if you took the discount?
34) The Bike Store orders $2000 worth of supplies every 30 days. If they take advantage of the
3/10 net 30 discount offered by their supplier, how much would they save over the year? Assume
a 360-day year.
35) What are the most important types of current assets? List your answer in order of declining
liquidity.
1) Carrying inventory reduces the costs associated with periodic bad debt losses.
2) The EOQ model calculates the size of the firm’s inventory given its expected usage, carrying
costs, and ordering costs.
3) In the EOQ model the optimal ordering quantity is the quantity for which the sum of the costs
of ordering and carrying inventory is minimized.
4) Non-uniform demand can be accommodated in the EOQ model by allowing for non-uniform
ordering costs.
5) Safety stock may be included into the EOQ model to alleviate problems caused by violation of
the assumptions of constant demand and instantaneous delivery.
6) Anticipatory buying occurs because of an anticipated decrease in interest rates.
7) EOQ model recommendations may be replaced by anticipatory buying during periods of high
inflation.
8) As inflation pushes interest rates up, the cost of carrying inventory rises.
9) Determination of safety stock involves a tradeoff between the risk of a stock-out and increased
costs of carrying additional inventory.
10) In the EOQ model, the carrying cost on inventory should include the required rate of an
investment in inventory.
11) The EOQ model assumes constant demand and constant unit price.
12) The just-in-time inventory control system is just a new approach to the EOQ model which
tries to produce the lowest average inventory possible.
13) The purpose of maintaining a raw materials inventory is to integrate the purchasing and
production functions.
14) Two factors that go into the determination of the appropriate order point are the deliver-time
stock and the safety stock required.
15) The purpose of finished goods inventory is to uncouple the production and sales functions so
that it is not necessary to produce the goods before a sale can occur.
16) The purpose of work-in-process inventory is to ensure that machine failures and work
stoppages in one operation do not affect other operations.
17) The purpose of carrying inventory is to
A) make different production processes more dependent on sales.
B) make sales more independent of the production process.
C) have collateral for loans.
D) improve the current ratio.
18) Of the following EOQ model assumptions, the most limiting is
A) uniform demand.
B) constant unit price.
C) constant ordering costs.
D) independent orders.
19) In the basic EOQ model the optimal inventory level is the point at which
A) total cost is minimized.
B) total revenue is maximized.
C) carrying costs are minimized.
D) ordering costs are minimized.
20) If the variables in the EOQ inventory model are defined as: S = total units demanded during
the planning period, O = ordering costs per order, C = carrying costs per unit and Q = inventory
order size in units, then the average level of inventory which a company should have during the
planning period is
A) 2/3 Q.
B) 1/2 Q.
C) SO/C.
D) 1/2 S.
21) Wagner Curios estimates that it will sell 30,000 porcelain figurines next year. Because
porcelain figurines are so easily damaged, the average per unit carrying cost of the figurines is
$25. The per order cost of ordering is $800. Assume that Wagner wants a safety stock of 75
figurines. If Wagner reorders the figurines based on the economic order quantity, what is
Wagner’s average inventory of porcelain figurines?
A) 768
B) 854
C) 628
D) 700
22) Williams Toy Company will use an estimated 700,000 small processors in its manufacturing
process next year. The carrying cost of processor inventory is $3.00 per unit and the cost of
reordering processors is $100 per order. What is Williams Toy Company’s economic ordering
quantity for small processors?
A) 6,340
B) 6,831
C) 7,118
D) 7,300
23) Stein Corporation uses semi-hex joints in its manufacturing process. If Stein’s total demand
for the joints for next year is estimated to be 57,000 units, and if the cost per order is $225, what
is Stein’s economic order quantity of semi-hex joints? Assume that carrying costs for semi-hex
joints are $0.75 per unit.
A) 3,729
B) 3,987
C) 4,944
D) 5,848
24) The Steady Fork Company will use an estimated 24,000 wheel assemblies in its
manufacturing process next year. The carrying cost of the wheel assembly inventory is $1.80 per
wheel and the ordering cost per order is $50. What is Steady Fork’s economic ordering quantity
of wheel assemblies?
A) 785
B) 997
C) 1,098
D) 1,155
25) How do interest rates affect the optimal order quantity Q*?
A) As interest rates increase, Q* decreases.
B) As interest rates decrease, Q* decreases.
C) As interest rates increase, Q* increases until it reaches a maximum, after which any further
increase in interest causes a decline in Q*.
D) None of the above.
26) Which of the following is not a category of inventory?
A) raw materials
B) work-in-process
C) purchases
D) finished goods
27) In the EOQ model, carrying costs of inventory include
A) the required rate of return on inventory.
B) wages for warehouse workers.
C) costs associated with inventory shrinkage.
D) B and C.
E) all of the above.
28) Inflation affects the EOQ model in all of the following ways except:
A) changing the investment in accounts receivable.
B) encourages anticipatory buying.
C) increased carrying costs.
D) encourages buying early to avoid price increases.
29) Which of the following is not an underlying assumption of the EOQ?
A) uniform demand
B) constant unit price
C) variable carrying cost
D) instantaneous delivery
30) Black Appliances is trying to determine the optimal order quantity for dryers for the next
twelve months. Annual sales are expected to be 1,000,000 units at a retail price of $400 each.
The cost of carrying dryers is $80 per year. Studies show that it costs Black $250 to prepare and
receive an order. What is the EOQ?
A) 2,750
B) 2,500
C) 2,000
D) 1,850
31) Fiesta Taco Company purchases 30,000 boxes of ground beef each year. It costs $50 to place
each order and $10.00 per year for each box held as inventory.
a. What is the average inventory held during the year?
b. What is the economic order quantity for the ground beef?
c. How many orders will be made each year?
32) Manfred Manufacturing is involved in the production of machine parts. The company uses
600,000 pounds of steel annually. The current purchasing cost for steel is $3.20 per pound. The
carrying cost for inventory is 10 percent of the purchase price. The cost of ordering steel is $800
per order. The company has decided to maintain a safety stock of 15,000 pounds. The delivery
time per order is 6 days. The company works 365 days a year.
a. Determine the optimal EOQ.
b. How many orders will be placed annually?
c. What is the average inventory?
d. What is the inventory order point? (That is, at what level of inventory should a new order
be placed?)
e. What is the company’s total inventory costs for the year?
33) A flower shop is trying to determine the optimal order quantity of the wicker baskets that it
places many of its arrangements in. The store thinks it will sell 2000 of these baskets over the
next year. The baskets cost the shop $2.00 each. The carrying costs of the baskets is $0.15 each
per year. It costs the shop $8.00 to order.
a. What is the economic order quantity?
b. What is the total cost for ordering the baskets once a year? Four times a year?
34) A local lamp store expects to sell 2000 lamps in the coming year. It costs the store $1.00 in
carrying costs for each lamp and $10.00 for each order placed.
a. What is the economic order quantity for the lamps?
b. How many orders will be placed each year?
c. If the store wants a one-week safety stock and it takes one week to receive an order after it
has been placed, what should the inventory level be when a new order is placed? Assume a 50-
week year.
35) A textile manufacturer has cloth that has a $14 per yard carrying cost per year. This cloth is
used at a rate of 25,000 yards per year, and ordering costs are $10 per order.
a. What is the economic order quantity for this cloth?
b. What are the annual inventory costs for this firm if it orders in this quantity?
36) The economic order quantity (EOQ) model is well accepted. However, there are weaknesses
associated with several of its assumptions. What are these weaknesses?