Deck 17: Financial Planning and Control

Question 1

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.

Answer 1

True

Question 2

"Stretching" accounts payable is a widely accepted and costless financing technique.

Answer 2

False

Question 3

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.

Answer 3

True

Question 4

A firm is said to be extending net trade credit when its accounts receivable are less than its accounts payable.

Question 5

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.

Question 6

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.

Question 7

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.

Question 8

Trade credit is an inexpensive source of short-term financing if no discounts are offered.

Question 9

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.

Question 10

The calculated cost of trade credit is reduced by paying late.

Question 11

A line of credit and a revolving credit agreement are similar except that a line of credit creates a legal obligation for the bank.

Question 12

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.

Question 13

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.

Question 14

When a firm has accounts payable that are greater than the level of its receivables, the firm is actually receiving net trade credit.

Question 15

One of the disadvantages of not taking trade credit discounts when offered is that the firm's investment in accounts payable rises.

Question 16

Trade credit and accrual accounts are always costless sources of spontaneous financing for the firm.

Question 17

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.

Question 18

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.

Question 19

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.

Question 20

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.

Question 21

Trade credit is seldom used by firms and is an insignificant component of short-term debt for most firms.

Question 22

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.

Question 23

A bank with fluctuating deposit liabilities in a static community will tend to follow creative banking practices when approving loans.

Question 24

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.

Question 25

A promissory note is a document specifying the terms and conditions of a loan, including the amount, interest rate, and repayment schedule.

Question 26

The risk of default on pledged accounts receivable is borne by the lender to whom the receivables are pledged.

Question 27

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.

Question 28

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.

Question 29

When a firm factors its accounts receivable, the factor normally performs the functions of risk bearing, credit checking, and lending.

Question 30

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.

Question 31

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.

Question 32

The factor (lender) purchasing accounts receivable from borrower has recourse against the borrower if the accounts receivable cannot be collected.

Question 33

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.

Question 34

Liabilities such as wages and taxes that increase spontaneously with operations are called accruals.

Question 35

Factoring involves the outright sale of accounts receivable.

Question 36

The pledging of receivables differs from factoring in that, under pledging, the lender normally has recourse against the borrower.

Question 37

Commercial paper is a type of secured promissory issued by large, strong financial firms.

Question 38

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.

Question 39

The uniform commercial code is a system of standards that simplifies procedures for establishing loan security.

Question 40

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.

Question 41

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.

Question 42

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.

Question 43

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.

Question 44

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.

Question 45

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.

Question 46

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.

Question 47

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

Question 48

Firms having difficulty borrowing short-term funds from banks can raise short-term funds by issuing commercial paper.

Question 49

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.

Question 50

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.

Question 51

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.

Question 52

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.

Question 53

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.

Question 54

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.

Question 55

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.

Question 56

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.

Question 57

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.

Question 58

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

Question 59

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.

Question 60

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.

Question 61

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%

Question 62

Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year.The firm receives payment from its harvests sometime after shipment.Due in part to the firm's rapid growth, it has been borrowing to finance its harvests using 90-day bank notes on which the firm pays 12 percent discount interest.If the firm requires $60,000 in proceeds from each note, what must be the face value of each note?

A)$61,856
B)$67,531
C)$60,000
D)$68,182
E)$67,423

Question 63

Coverall Carpets Inc.is planning to borrow $12,000 from the bank.The bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments.What is the effective rate of interest on the 12 percent discounted loan?

A)10.7%
B)12.0%
C)12.5%
D)13.6%
E)14.1%

Question 64

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.

Question 65

In this problem, use the approximation formula to find the cost of trade credit.A firm's payments policy calls for stretching payments to its supplier, who sells on terms of 3/20, net 60.Payment is made in 90 days, and the cash saved is invested in a money market mutual fund paying 12 percent interest.This policy is a net ____.

A)Profitable; gain of about 9 percent on the funds involved.
B)Profitable; gain of about 12 percent on the funds involved.
C)Unprofitable; loss of about 4 percent on the funds involved.
D)Unprofitable; loss of about 9 percent on the funds involved.
E)Insufficient information to solve.

Question 66

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%

Question 67

Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and harvest its fruit crop.Picard borrows on a discount interest basis at a simple annual rate of 11 percent.If Picard must actually receive $100,000 net proceeds to finance its crop, then what must be the face value of the note?

A)$111,000
B)$100,000
C)$112,360
D)$89,000
E)$108,840

Question 68

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.

Question 69

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.

Question 70

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.

Question 71

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.

Question 72

If you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, but interest is prepaid (a discounted loan), then what is your effective annual rate?

A)14.00%
B)8.57%
C)16.28%
D)21.21%
E)28.00%

Question 73

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.

Question 74

Phillips Glass Company buys on terms of 2/15, net 30.It does not take discounts, and it typically pays 30 days after the invoice date.Net purchases amount to $720,000 per year.On average, how much "free" trade credit does Phillips receive during the year?

A)$30,000
B)$40,000
C)$50,000
D)$60,000
E)$70,000

Question 75

Your company has been offered credit terms on its purchases of 4/30, net 90.What will be the approximate cost of trade credit if your company pays on the 35th day after receiving the invoice?

A)30%
B)300%
C)3%
D)87%
E)156%

Question 76

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.

Question 77

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.

Question 78

A loan that is backed by collateral is a(n) loan.

A)senior
B)amortized
C)subordinate
D)commercial
E)secured

Question 79

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.

Question 80

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.