Deck 16: Managing Short-Term Liabilities Financing

Question 1

The four major elements in a firm's credit policy are (1) credit standards, (2) credit terms, (3) monitoring function, and (4) collection policy.

Answer 1

True

Question 2

If there are large fluctuations in a firm's cash flows, or if there are large costs associated with selling securities, then the firm should hold relatively small average cash balances.

Answer 2

False

Question 3

Firms hold cash balances in order to complete transactions that are necessary in business operations and as compensation to banks for providing loans and services.

Answer 3

True

Question 4

Inventory management focuses on three basic questions: (1) how many units to hold in stock, (2) how many units of each item to order, and (3) at what point to reorder.

Question 5

Fixed dividend preferred stock is a good candidate for marketable security holdings designed to provide liquidity because 70 percent of the dividends are excludable from taxable income, hence the preferred would provide a relatively high after-tax rate of return.

Question 6

The term "interest rate price risk" refers to the probability that a firm will be unable to continue making interest payments on its debt.

Question 7

Lockbox arrangements are one way for a firm to speed up the receipt of payments from customers.

Question 8

Target cash balances are generally not affected by compensating balance requirements except during periods of high interest rates and tight money.

Question 9

The central goal of inventory management is to provide sufficient incentives to ensure that the firm never suffers a stock-out (i.e., runs out of an inventory item).

Question 10

Inventory management is largely self-contained; that is, only minimum coordination among other departments such as sales, purchasing, and production is required for successful inventory management.

Question 11

A firm's target cash balance should be set as the smaller of (1) its transaction balance plus a precautionary (safety stock) balance or (2) its required compensating balance.

Question 12

The primary purpose of compensating balances required of borrowers is to compensate the bank in the event the borrower defaults on the loan.

Question 13

The average accounts receivables balance is determined jointly by the volume of credit sales and the days sales outstanding.

Question 14

Offering trade credit discounts is costly to a firm and as a result, firms that offer trade discounts are usually those that are performing poorly and need cash quickly.

Question 15

For a firm that makes heavy use of float, being able to forecast its collections and disbursement check clearings is essential.

Question 16

Credit associations and credit reporting agencies are two major sources of external credit information on credit customers.

Question 17

If you receive some goods on April 1 with the terms 3/20, net 30, June 1 dating, it means that you will receive a 3 percent discount if the bill is paid on or before June 20 and that the full amount must be paid 30 days after receipt of the goods.

Question 18

Generally, ordering costs are the single most important cost element in inventory management, because they are greater in magnitude than carrying costs.

Question 19

The benefits of a sound cash management program are not sensitive to interest rates.

Question 20

Two of the primary motives for a firm to hold cash are the transaction motive and the precautionary motive.

Question 21

The economic order quantity is that order quantity which results in the minimum ordering costs.

Question 22

If the carrying costs of inventory increase then the economic ordering quantity of inventory will increase to insure the firm minimizes the total inventory costs.

Question 23

The credit period is length of time for which credit is granted; after that time, the credit account is considered delinquent.

Question 24

Exchange rates influence a multinational firm's inventory policy because changing currency values can affect the value of inventory.

Question 25

All else equal, firms that hold greater amounts of short-term assets are considered more risky than firms that hold grater amounts of long-term securities.

Question 26

The primary motivation behind out-sourcing is to provide the firm with an alternative source of supply in the event that its primary supplier is unable to meet the firm's raw material or component needs.

Question 27

The target cash balance is the minimum cash balance a firm desires to maintain in order to conduct business.

Question 28

The ABC method of inventory classification helps management concentrate resources on those inventory items that are most critical to the firm's operations.

Question 29

If the unit sales of a firm double, the optimal order quantity as determined by the EOQ model will also double.

Question 30

The collection policy refers to the procedures the firm follows to collect its credit accounts.

Question 31

The threat of expropriation creates an incentive for the multinational firm to minimize inventory holdings and to bring in goods only as needed.

Question 32

A just-in-time system of inventory control requires that manufacturers coordinate production with suppliers so that raw materials or components arrive just as they are needed in the production process.The main objective of such a system is to reduce carrying costs.

Question 33

The net float is the difference between the disbursement float and the collections float.

Question 34

Credit policy for the multinational firm is generally riskier due in part to the additional consideration of exchange rates and also due to uncertainty regarding the credit worthiness of many foreign customers.

Question 35

Short term assets generally earn a higher rate of return than long-term assets, making short term assets a more desirable investment than long-term assets.

Question 36

If the forecasted sales or usage rate is not accurate, the EOQ model may not lead to efficient inventory management.

Question 37

Two commonly used methods of monitoring receivables are the DuPont method and the aging schedule.

Question 38

Synchronization of cash flows is an important cash management technique and effective synchronization can actually increase a firm's profitability.

Question 39

The terms of credit include the length of the credit period and any cash discounts offered.

Question 40

A Eurodollar is a U.S.dollar deposited in a bank outside the United States.

Question 41

Which of the following actions in managing the cash account would, in general, either not be feasible or else not be consistent with the firm's wealth maximization objective?

A)Increase synchronization of inflows and outflows.
B)Use drafts for disbursing funds.
C)Use a lockbox plan.
D)Maintain an average balance which is equal to that required as a compensating balance or that which minimizes total cash management costs, whichever is lower.
E)None of the above (all would be feasible and consistent actions).

Question 42

If easing a firm's credit policy lengthens the collection period and results in a worsening of the aging schedule then why do firms take such actions?

A)It normally stimulates sales.
B)To meet competitive pressures.
C)To increase the firm's deferral period for payables.
D)All of the above.
E)Both a and b above.

Question 43

Borrowing and holding marketable securities are substitute financing alternatives, although the two strategies may have different costs.

Question 44

Collections float offsets disbursement float.If a firm's collections float is greater than its disbursement float then a firm is said to operate with positive net float.

Question 45

Generally, the longer the normal inventory holding period of a customer the longer the credit period.One effect of extending the credit period to match the customer's merchandise holding period is to increase the customer's payables deferral period which actually serves to shorten the customer's cash conversion cycle.

Question 46

If the average collection period or days sales outstanding is increasing the firm should consider easing its credit policy to allow credit to more of its customers.

Question 47

Which of the following is not a situation which might lead a firm to hold marketable securities:

A)The firm has purchased a fixed asset which will require a large write-off of depreciable expense.
B)The firm must meet a known financial commitment, such as financing an ongoing construction project.
C)The firm must finance seasonal operations.
D)The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.
E)None of the above (all of the situations might lead the firm to hold marketable securities).

Question 48

If your firm's DSO or aging schedule deteriorates from the first quarter of the year to the second quarter, this is a clear indication that your firm's credit policy has weakened.

Question 49

Which of the following investments is not likely to be a proper investment for temporarily idle cash?

A)Commercial paper.
B)Treasury bills.
C)Recently issued long-term corporate bonds.
D)Government bonds due shortly.
E)AT&T bonds due within one year.

Question 50

A lockbox plan is one method of speeding up the check-clearing process for customer payments and decreasing the firm's net float position.

Question 51

Which of the following statements concerning the cash budget is true?

A)Depreciation expense is not explicitly included, but depreciation effects are implicitly included in estimated tax payments.
B)Cash budgets do not include financial expenses such as interest and dividend payments.
C)Cash budgets do not include cash inflows from long-term sources such as bond issues.
D)Answers a and b above.
E)Answers a and c above.

Question 52

Analyzing days sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables.However, they can provide erroneous signals to credit managers when

A)Customers' payments patterns are changing.
B)Sales fluctuate seasonally.
C)Some customers take the discount and others do not.
D)Sales are relatively constant, either seasonally or cyclically.
E)None of the above.

Question 53

A firm has a daily average collection of checks equal to $250,000.It takes the firm approximately 4 days to convert the funds into usable cash.Assume (1) a lockbox system could be employed which would reduce the cash conversion procedure to 21/2 days, and (2) the firm could invest any additional cash received at 6 percent after taxes.The lockbox system would be a good buy if it costs only $23,000 annually.

Question 54

In part because money has time value, cash sales are always more profitable and more valuable than credit sales.

Question 55

Which of the following statements is correct?

A)A lockbox system is an example of concentration banking.
B)For a firm that has many divisions or plants operating over a wide geographic area, payables centralization offers little benefit.
C)If a firm increases its disbursement float, its net float will also increase, other things held constant.
D)There are no actions a firm can take to improve its synchronization of cash flows.
E)A lockbox system does not affect collections float.

Question 56

If a firm's terms are 2/10, net 30 days, and its DSO is 28 days, we can be certain that the credit department is functioning efficiently and the percentage of past due accounts is minimal.

Question 57

A lockbox plan is

A)A method for safe-keeping of marketable securities.
B)Used to identify inventory safety stocks.
C)A system for slowing down the collection of checks written by a firm.
D)A system for speeding up a firm's collections of checks received.
E)Not described by any of the above statements.

Question 58

A firm's collection policy and the procedures it follows to collect accounts receivable play an important role in keeping its deferrables period short, although too strict a collection policy can result in outright losses due to non- payment.

Question 59

Other things equal and held constant, a firm with an effective accounts receivable monitoring system, when compared with a firm without such a monitoring system, will likely have lower additional funds needed.

Question 60

Which of the following is (are) typically part of the cash budget?

A)Payment lag.
B)Payment for plant construction.
C)Cumulative cash.
D)All of the above.
E)Only answers a and c above.

Question 61

The amount of checks that have been received and deposited but have not yet been made available to the account in which they were deposited is the float.

A)disbursement
B)net
C)collections
D)balance
E)deposit

Question 62

Which of the following statements is correct?

A)Poor synchronization of cash flows which results in high cash management costs can be partially offset by increasing disbursement float and decreasing collections float.
B)The size of a firm's net float is primarily a function of its natural cash flow synchronization and how it clears its checks.
C)Lockbox systems are used mainly for security purposes as well as to decrease the firm's net float.
D)If a firm can speed up its collections and slow down its disbursements, it will be able to reduce its net float.
E)A firm practicing good cash management and making use of positive net float will bring its check book balance as close to zero as possible, but must never generate a negative book balance.

Question 63

Which of the following statements about cash management is false?

A)Depreciation expense does not appear explicitly on the cash budget, but its tax effects are included.
B)If cash flows are not uniform during the month, then weekly or perhaps daily cash budgets should be prepared rather than monthly budgets.
C)Compensating balance requirements do not affect a firm's target cash balance.
D)Cash management involves costs, and it is important to analyze whether the benefits received outweigh the costs incurred.
E)The cash budget is the foundation of good cash management.

Question 64

Which of the following statements is correct?

A)Compensating balance requirements apply only to businesses, not to individuals.
B)Compensating balances are essentially costless to most firms, because those firms would normally have such funds on hand to meet transactions needs anyway.
C)If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.
D)Banks are prohibited from earning interest on the funds they force businesses to keep as compensating balances.
E)All of the above statements are correct.

Question 65

A cash balance held in reserve for unforeseen fluctuation in cash flows is called a balance.

A)transactions
B)compensating
C)precautionary
D)speculative
E)cash

Question 66

is a technique used to reduce float by having payments sent to post office boxes located near the customer.

A)Postal deposit system
B)Preauthorized debit system
C)Concentration banking
D)Lockbox arrangement
E)Zero-balance account

Question 67

Having synchronized cash flows enables a firm to

A)increase its cash balances.
B)increase its bank loans.
C)increase interest expense.
D)increase profits.
E)None of the above.

Question 68

Which of the following is not a reason for a firm to hold cash balances?

A)To cover routine payments and collections.
B)To earn high rates of interest.
C)To meet compensating balance requirements of banks.
D)To provide a safety stock in the event of unforeseen fluctuations into cash flows.
E)To take advantage of bargain purchases that might arise.

Question 69

Which of the following statement completions is correct? If the yield curve is upward sloping, then a firm's marketable securities portfolio, assumed to be held for liquidity purposes, should be

A)Weighted toward long-term securities because they pay higher rates.
B)Weighted toward short-term securities because they pay higher rates.
C)Weighted toward U.S.Treasury securities to avoid interest rate risk.
D)Weighted toward short-term securities to avoid interest rate risk.
E)Balanced between long- and short-term securities to minimize the effects of either an upward or a downward trend in interest rates.

Question 70

Which of the following statements is correct?

A)Shorter term cash budgets, in general, are used primarily for planning purposes while longer term budgets are used for actual cash control.
B)The cash budget and the capital budget are planned separately and although they are both important to the firm, they are independent of each other.
C)Since deprecation is a non-cash charge, it does not appear on nor have an effect on the cash budget.
D)The target cash balance is set optimally such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it is changed to reflect long-term changes in the firm's
Operations.
E)The typical actual cash budget will reflect interest on loans and income from investment of surplus cash. These numbers are expected values and actual results might turn out differently.

Question 71

A report showing how long accounts receivable have been outstanding is called what?

A)Time line.
B)Preauthorized debit system.
C)Aging schedule.
D)Cash discount.
E)Credit period.

Question 72

The value of checks that have been written and disbursed but have not been deducted from the account on which they were written is the float.

A)disbursement
B)net
C)collections
D)balance
E)deposit

Question 73

A minimum checking account balance that a firm must maintain with bank to help offset the costs and services such as check clearing and cash management advice is called a balance.

A)transactions
B)compensating
C)precautionary
D)speculative
E)convertible

Question 74

What type of system allows a customer's bank to periodically transfer funds from its account to a selling firm's bank account for payment of bills?

A)Disbursement agreement.
B)Preauthorized debit system.
C)Lockbox agreement.
D)Concentration banking system.
E)Zero-balance account.

Question 75

Which of the following is not a reason for firms to own marketable securities?

A)Marketable securities serve as a substitute for cash balances.
B)Marketable securities offer a place to temporarily put cash balance to work earning a positive return.
C)Marketable securities are used as a temporary investment to finance seasonal or cyclical operations.
D)Marketable securities are used as a temporary investment to amass funds to meet financial requirements in the near future.
E)Marketable securities are more liquid than cash balances.

Question 76

Which of the following might be attributed to efficient inventory management?

A)High inventory turnover ratio.
B)Low incidence of production schedule disruptions.
C)High total asset turnover.
D)All of the above.
E)Only answers a and c above.

Question 77

A cash balance that is held to enable the firm to take advantage of any bargain purchases that might arise is called a ____ balance.

A)transactions
B)compensating
C)precautionary
D)speculative
E)convertible

Question 78

In the text, the "red-line method" refers to

A)The policy of drawing a red line around certain neighborhoods on a map and then refusing to sell on credit to people who live within those areas.
B)Restrictions imposed by companies which insure credit risks.
C)The use, in Dun & Bradstreet's reports, of a red line to show the maximum amount of credit which should be extended to a given customer; companies using this limit when they screen customers' orders are said to be using the "red-line method."
D)A method of controlling inventories by drawing a red line on the inside of a bin.
E)A method of controlling receivables by drawing a red line on invoices of companies that are expected to pay late.

Question 79

A liquid asset is an asset can be sold in a period of time at a price its fair market value.

A)relatively long; way below
B)relatively long; near
C)relatively short; way below
D)relatively short; near
E)None of the above.

Question 80

Which of the following statements is correct?

A)The optimal credit policy is determined primarily by the industry in which the firm operates and by current economic conditions.
B)Normally, when a credit sale is made, inventory is reduced by the cost of goods sold and an equal amount is credited to accounts receivable.
C)A typical business credit report provides sufficient information to eliminate the need for informed human judgment in the credit decision.
D)A customer's credit quality is usually determined in terms of the probability of the customer's default.
E)Computers have had a significant effect in increasing efficiency in the areas of payroll and inventory, but have had little impact in accounts receivable management.