Deck 12: Risk, Return, and Capital Budgeting

Question 1

A firm that buys on credit is in effect borrowing from its supplier.

Answer 1

True

Question 2

A banker's acceptance is usually used in overseas trade.

Answer 2

True

Question 3

The more liberal the terms of the collection policy,the less the potential for bad debts and unprofitable sales.

Answer 3

False

Question 4

Since defaults can be costly,it is cost-effective to undertake a full credit analysis of all customers.

Question 5

The potential benefits of additional credit analysis should always be weighed against the incremental costs.

Question 6

A company gains,as a result of net float,the amount on checks that has been deposited by a company but that has not been cleared.

Question 7

Bond ratings are an inexpensive source of credit information on publicly traded companies.

Question 8

A corporation such as Walmart with about $400 billion of annual sales has an average daily cash flow of more than $1,096 million.

Question 9

In 2007,banks across the world revealed huge losses in the U.S.subprime mortgage market.Investors shrank from illiquid securities and there was a "flight to quality."

Question 10

Lock-box systems allow local banks to collect and process the firm's remittance from that area.

Question 11

Profits are maximized in a firm when the number of bad accounts is minimized.

Question 12

The total value of payments going through the Fedwire and CHIPS Payment systems is nearly one thousand trillion dollars a year.

Question 13

When you deposit a check,there is a delay before it gets credited to your bank account.This reduces your available balance compared to your ledger balance.Your net float is the difference between the balance in your company ledger and the balance recognized by your bank.

Question 14

An aging schedule is a statement sent to customers who are behind in payments.

Question 15

Short-term securities have high interest-rate risk.

Question 16

As the number of inventory orders per year increases,the total order costs increase.

Question 17

In 2007,the spread between the yields on commercial paper and Treasury bills increased to over 100 basis points (1.00%).

Question 18

While many firms may hold too much cash,it is virtually impossible to hold too little cash.

Question 19

Just-in-time inventory management is suitable for an aircraft manufacturer,like Boeing,whose production schedules are known well in advance.

Question 20

Optimal inventory levels are lower when carrying costs are high,and are higher when the cost of restocking inventories is high.

Question 21

The economic order quantity:

A) is the order size that minimizes the costs of orders.
B) is independent of forecast sales.
C) is a simplified, and even simplistic, version of the real process.
D) increases as cost per order decreases.

Question 22

The cost of holding inventory is the interest paid on the money used to buy the inventory.

Question 23

The decision to offer credit depends on the probability of payment.You should grant credit if the expected profit from doing so is greater than the profit from refusing.

Question 24

Concentration banking allows the banks to use the local collection system to clear the customers' checks.

Question 25

In order to maintain a zero-balance account,a firm transfers all collections to a single account.

Question 26

Which firm will benefit the most from a lock-box service?

A) A firm that has a large number of suppliers
B) A firm that writes a large number of checks daily
C) A firm that has a geographically dispersed customer base
D) A firm that sells goods to a very few customers

Question 27

When sales are made without the accompaniment of a formal debt contract,the sales are said to be on:

A) conditional sale terms.
B) open account.
C) trade credit.
D) sight draft.

Question 28

Extending trade credit can increase the probability of repeat orders.

Question 29

The break-even probability of collection is positively related to the firm's percentage of profit margin.

Question 30

A common characteristic of money market instruments is their high degree of liquidity.

Question 31

An East Coast firm should establish a lock-box service on the West Coast:

A) if the firm has a large number of customers.
B) if it has banking facilities in West Coast.
C) if West Coast customers are currently mailing their checks to an East Coast address.
D) if West Coast banks are more efficient.

Question 32

With terms of 4/15,net 60,what is the implied interest rate for forgoing a cash discount and paying at the end of the period?

A) 25.63%
B) 28.19%
C) 39.25%
D) 61.15%

Question 33

Which of the following statements is not true?

A) Optimal inventory levels involve a trade-off between carrying costs and order costs.
B) Carrying costs include the cost of storing goods as well as the cost of capital tied up in inventory.
C) Inventory levels will be lower when storage or interest costs are high and will be higher when restocking costs are high.
D) Inventory level does not rise in direct proportion to sales. As sales increase, the optimal inventory level rises, but more than proportionately.

Question 34

Repos are long-term unsecured loan agreements.

Question 35

Which of the following terms of sale is the most restrictive?

A) Net 30
B) Seasonal dating
C) CBD
D) COD

Question 36

A firm that is located in New York receives on the average 2,000 checks a day from its customers in the Twin Cities area.Average payment per check is $1,500.A bank in the Twin Cities is offering a lock-box arrangement for collection and processing of these checks at a cost of $0.50 per check.This arrangement will reduce the float by 2 days.The daily interest rate for the firm is 0.02%.What is the net saving from the lock-box arrangement?

A) $200
B) $400
C) $1,000
D) $1,200

Question 37

Which statement is true about terms of trade credit of 2/10,net 30?

A) A 10% cash discount is offered for payment before 30 days.
B) A 2% cash discount can be taken for payment before the 10^th of the following month.
C) A 10% cash discount can be taken if paid by the second day after invoicing.
D) No cash discount is offered after the eleventh day.

Question 38

One way of handling uncertain cash flows is to set an upper and lower limit for cash balances and a return point to which the cash balance is brought to when the upper or lower limit is reached.

Question 39

At what point does a customer's unpaid account become delinquent when the terms of sale are 2/10,net 60?

A) 11 days after the sale
B) 31 days after the sale
C) 61 days after the sale
D) 71 days after the sale

Question 40

What happens to the implied interest rate on trade credit as the time interval between the discount period and payment period is decreased?

A) The rate declines.
B) The rate increases.
C) The rate remains constant.
D) It is impossible to predict without knowing length of discount period.

Question 41

The set of rules that determines whether or not to extend credit is known as:

A) credit analysis.
B) credit policy.
C) multiple discriminate analysis.
D) the terms of trade credit.

Question 42

Average daily collection of checks for a firm is $50,000.The firm also writes on the average $35,000 of checks daily.If the collection period for checks is 5 days,calculate the net float.

A) -$75,000
B) $75,000
C) -$425,000
D) $425,000

Question 43

Which of the following would be least expected to change as a result of a higher average age of receivables?

A) Current ratio
B) Total collection costs
C) Accounts payable
D) Bad debt expense

Question 44

It may be possible for firms to reduce the time and expense necessary to collect delinquent debts under a(n):

A) promissory note.
B) conditional sale.
C) open account.
D) EOM billing.

Question 45

An accepted time draft is quite similar to:

A) selling on open account.
B) a conditional sale.
C) a check dated in the future.
D) an overdue account.

Question 46

Which of the following statements is correct about banker's acceptances?

A) They are equivalent to a sight draft.
B) They represent the norm for installment sales.
C) The bank guarantees payment of the invoice.
D) The bank retains title to the merchandise.

Question 47

Which of the following elements of credit terms might discourage purchasers from paying with a discount?

A) A higher discount percentage
B) A shorter payment period
C) A longer discount period
D) A longer payment period

Question 48

An aging schedule illustrates the relationship between:

A) customers and repeat sales.
B) sales and profitability.
C) the ratio of accounts receivable to sales.
D) accounts receivable and their average time outstanding.

Question 49

Which of the following credit agreements will provide the highest likelihood of cash payment to a seller of goods?

A) Banker's acceptance
B) Time draft
C) Open account
D) Conditional sale

Question 50

Under the terms of a sight draft,the buyer's bank:

A) is instructed to make immediate payment.
B) treats the invoice like a postdated check.
C) forwards the acceptance to the seller until due.
D) treats the purchase as a conditional sale.

Question 51

Which of the following would not be included in the five Cs of credit?

A) Character
B) Condition
C) Charges
D) Capital

Question 52

Money market securities usually have a maturity of:

A) more than 1 year.
B) less than 1 year.
C) 1 to 3 years.
D) less than 91 days.

Question 53

Which of the following strategies would continue to be effective if a cash-strapped firm determines that the effective interest rate charged on trade credit is lower than the bank's interest rate?

A) Take the discount but pay after the discount period.
B) Borrow from the bank and take the discount.
C) Ignore the discount, pay at the end of the period.
D) Take the discount and hope for longer payment float.

Question 54

Credit scoring systems can be used to:

A) reduce the effective cost of trade.
B) determine the cost of goods sold.
C) evaluate Dun and Bradstreet reports.
D) evaluate credit risk based on the borrower's characteristics.

Question 55

A firm offered 3/10,net 30 as terms of trade credit on a $1,000 invoice dated January 1.How much must the purchaser offer to pay in full on January 4?

A) $970.00
B) $971.16
C) $1,000.00
D) $1,030.00

Question 56

Which of the following would not be a customary source of credit information on customers?

A) Dun and Bradstreet
B) Internal Revenue Service
C) Credit Bureau
D) Customer's bank

Question 57

Which of the following changes to the terms of credit would make the effective annual rate increase?

A) Increase the cash discount percentage.
B) Extend the discount period.
C) Extend the payment period.
D) All of these.

Question 58

Which of the following credit agreements provides the least protection to the seller?

A) Banker's acceptance
B) Conditional sale
C) Open account
D) Commercial draft

Question 59

Which of the following is correct concerning terms of trade credit of 4/10,EOM,net 90?

A) The discount period expires on the last day of the month.
B) The invoice becomes delinquent 90 days after the last day of the month.
C) The discount period ends on the 10^th day of the month following the invoice.
D) The discount period ends either 10 days after invoicing or at the end of the month, whichever is earlier.

Question 60

Higher Z scores from a multiple discriminate analysis indicate a:

A) higher risk of bankruptcy.
B) lower degree of creditworthiness.
C) lower amount of working capital.
D) higher degree of solvency.

Question 61

Preauthorized payments allow customers to:

A) pay the bills using a credit card.
B) arrange with their bank to have the account debited directly.
C) allow creditors to charge their credit card directly.
D) agree to pay the loan in fixed installments, with interest.

Question 62

What is the benefit for a firm with daily sales of $30,000 to be able to speed up collections by 3 days,assuming an 8% annual opportunity cost of funds?

A) $7,200 daily benefit
B) $7,200 annual benefit
C) $30,000 annual benefit
D) $90,000 annual benefit

Question 63

According to credit experts,a full credit analysis should be conducted:

A) on each customer of a firm.
B) only when payment is doubtful.
C) only on customers that are delinquent.
D) on all repeat customers.

Question 64

How many cases of microwave popcorn are sold annually by a firm that has total annual order costs of $32,000,orders in units of 100 cases,and is charged $90 per order in addition to the $72 per case product cost?

A) 20,250 cases
B) 35,556 cases
C) 44,444 cases
D) 49,383 cases

Question 65

Which of the following financial ratios is not used to develop Altman's Z-score from multiple discriminant analysis?

A) Market value of equity/book debt
B) EBIT/total assets
C) Interest expense/total assets
D) Working capital/total assets

Question 66

Find the break-even size of wire transfer if the cost of wire transfer is $20,the daily interest rate is 0.02%,and the reduction in float is 3 days.

A) $1,000
B) $25,000
C) $33,333
D) $100,000

Question 67

How can financial ratios be used to predict bankruptcy?

A) As early as 4 years before they went bankrupt, failing firms were earning a much lower return on assets (ROA) than firms that survived.
B) On average, failing firms also had a high ratio of liabilities to assets.
C) EBITDA (earnings before interest, taxes, depreciation, and amortization) was low relative to the firms' total liabilities.
D) All of these. In each case, these indicators of the firms' financial health steadily deteriorated as bankruptcy approached.

Question 68

Which of the following financial ratios has the highest weight in Altman's Z-score estimation?

A) Working capital/total assets
B) Retained earnings/total assets
C) EBIT/total assets
D) Sales/total assets

Question 69

A break-down of accounts receivable according to the length of time outstanding is known as a(n):

A) amortization schedule.
B) sources of cash flow statement.
C) receivables inventory.
D) aging schedule.

Question 70

ABC Corp.shows a ledger balance of $50,000 prior to writing a check for $5,000 and depositing $1,000 in checks.What is the amount of its net float?

A) $1,000
B) $4,000
C) $5,000
D) $6,000

Question 71

Which of the following is not likely to be a characteristic of a numerical credit scoring system?

A) Is used to prescreen credit applications
B) Analyzes financial ratios to determine credit
C) Is less subjective than using individual loan officers
D) Is most appropriate for consumer loans

Question 72

A retailer buys Christmas merchandize from the manufacturer on September 1.The manufacturer postdates the invoice to December 31,and the credit terms of the sale are 2/10,net 30.When is the payment due?

A) January 10
B) January 30
C) February 10
D) September 30

Question 73

Which of the following elements of credit terms might encourage purchasers from paying with a discount?

A) A lower discount percentage
B) A longer payment period
C) A shorter discount period
D) A shorter payment period

Question 74

What is the effective annual rate of trade credit if the trade credit terms are 1/10,net 30?

A) 13.01%
B) 18.00%
C) 18.43%
D) 20.13%

Question 75

The five Cs of credit refer to the:

A) credit reports issued by Dun and Bradstreet.
B) interpretation of numerical credit scoring systems.
C) attributes that help determine creditworthiness.
D) financial ratios used to determine Altman's Z-score.

Question 76

Which of the following statements is correct for a firm that currently has total costs of carrying and ordering inventory that are 50% higher than total carrying costs?

A) Current order size is greater than optimal.
B) Current order size is less than optimal.
C) Per unit carrying costs are too high.
D) The optimal order size is currently being used.

Question 77

You are buying goods worth $75,000 from a firm that offers the credit terms of 2/10,net 30.What will be the actual payment if you paid within 10 days?

A) $73,500
B) $74,250
C) $75,000
D) $76,500

Question 78

A firm issued three checks for $25,000,$15,000,and $13,000 on January 31,and deposited a $30,000 check into the bank account.None of the checks were cleared by February 1.What is the net float from these transactions?

A) -$23,000
B) +$23,000
C) -$83,000
D) +$83,000

Question 79

A manager estimates that her firm benefits from an average float time of 6 days.Which of the following is true if the firm averages $15,000 per day in payments?

A) The firm is losing interest on $90,000 per year.
B) The firm's ledger balance averages $90,000 more than the bank's ledger balance.
C) The firm has $45,000 in net float.
D) The available balance at the bank is $90,000 greater than shown on the firm's books.

Question 80

Assuming that a credit decision has been analyzed and credit refused due to a negative expected profit,which of the following changes,if of sufficient magnitude,might change the decision to one of approval?

A) Increase the percentage of profit margin.
B) Decrease the probability of payment.
C) Increase the discount rate.
D) Reduce the expected profit.