Question 1

A(n) ______ is a type of legal claim (lien) against a firm's inventory when it is used as collateral for a loan and the goods are relatively low priced, fast moving, and difficult to identify individually.

Accepted Answer

A blanket lien is a legal claim against a firm's inventory used as collateral for a loan. It covers all inventory owned by the firm and is commonly used when the goods are relatively low priced, fast moving, and difficult to identify individually. This type of lien is also used when a firm has multiple creditors with competing claims against its inventory.

Question 2

With a general line of credit, the bank:

Accepted Answer

The answer of With a general line of credit, the...

Question 3

Most firms purchase from their suppliers on credit, recording these debts in their financial statements/accounts as ______.

Accepted Answer

Accounts payable is the correct choice as it represents the amount owed to suppliers for goods or services purchased on credit. Notes payable and promissory notes are types of loans taken out by the firm, while inventory represents the goods or products held by the firm for sale. Accounts receivable, on the other hand, represents amounts owed to the firm by its customers.

Question 4

Which of the following mathematical equations is used to compute the effective annual rate (EAR)?

Accepted Answer

The equation to compute the effective annual rate (EAR) is EAR = (1 + Periodic rate of interest)number of borrowing (interest) periods in one year - 1. This is because the periodic rate of interest is added to 1 to get the total return for the period, and then this is raised to the power of the number of periods in one year to get the total return for the year. Finally, 1 is subtracted from this to get the effective annual rate.

Question 5

MoJo Corporation purchases goods on credit with terms of 4.5/15, net 40. Which of the following is the annual cost (APR) of the non-free trade credit if the firm pays on Day 40 (i.e., the cost of forgoing the discount)? In your computations, assume there are 360 days in a year.

Accepted Answer

The cost of forgoing the discount can be calculated using the following formula:
[(Discount % / (100 - Discount %)] x [360 / (Payable Period - Discount Period)]
[(4.5% / (100 - 4.5%)] x [360 / (40 - 15)]
[(4.5% / 95.5%)] x 12
0.0471 x 12
0.5652 or 56.52%
Therefore, the annual cost (APR) of the non-free trade credit if the firm pays on Day 40 is 56.52%, which is closest to option B (67.85%).

Question 6

All else equal, when a firm purchases raw materials on credit from its supplier, which of the following accounts is affected?

Accepted Answer

Purchasing raw materials on credit from a supplier means the firm owes the supplier money, creating a liability for the firm. This liability is recorded in the accounts payable account.

Question 7

Which of the following statements about various short-term credit alternatives is correct?

Accepted Answer

- A is incorrect because firms do not have complete control over the terms and levels of accruals; these are often influenced by industry practices and negotiations with suppliers. - B is incorrect because commercial paper is an unsecured form of promissory note.- C is incorrect because banks generally charge a commitment fee on the unused balances of credit lines, not the used balances.- D is correct because maintaining a compensating balance with a bank means that those funds are reserved and cannot be used for other purposes like paying bills or investing.- E is incorrect because the credit created when one firm buys goods or services on credit from another firm is known as accounts payable for the buyer and accounts receivable for the seller.

Question 8

Which of the following sources of financing is considered spontaneous because it fluctuates naturally with changes in ordinary business operations/transactions without management making formal decisions?

Accepted Answer

Trade credit is considered a spontaneous source of financing because it arises from the normal course of business transactions without any formal decision made by management. It is typically provided by suppliers who offer delayed payment terms to their customers. Commercial paper, long-term bonds, notes payable, and equity are not considered spontaneous sources of financing as they are typically obtained through formal financing decisions made by management.

Question 9

______ is a type of unsecured promissory note issued by large, financially strong firms.

Accepted Answer

Commercial paper is a type of unsecured promissory note issued by large, financially strong firms to raise short-term funds. The notes usually mature in less than 270 days and are typically issued at a discount from face value. Trade credit refers to the credit extended by one firm to another for the purchase of goods or services. A mortgage is a type of secured loan that uses a property as collateral. Preferred equity is a type of ownership in a company that usually carries preferential dividend payments but does not come with voting rights. An accrual arrangement refers to a contractual agreement to accrue and settle payments at a later date.

Question 10

A ______ is the document that specifies the terms and conditions of a bank loan, including the amount, interest rate, and repayment schedule.

Accepted Answer

A promissory note is a legally binding document that outlines the terms and conditions of a loan, including the amount borrowed, interest rate, and repayment schedule. It is signed by the borrower and serves as a written promise to pay back the loan according to the agreed-upon terms.

Question 11

A ______ is an arrangement in which a bank agrees to permit a firm to borrow any amount up to a specified maximum during a designated time period.

Accepted Answer

A line of credit is specifically designed to provide a company with access to cash when they need it, without having to continually apply for a new loan. It is a flexible funding arrangement that permits a company to borrow any amount up to a specified maximum during a designated period. Therefore, option A is the correct answer. B is incorrect because a commercial paper agreement refers to unsecured short-term debt that firms issue to raise funds quickly. Similarly, trade credit agreement refers to an agreement between a buyer and a seller where the buyer can purchase goods or services on credit terms from the seller. A promissory note is a legal document that contains a written promise from one party to pay another party a certain amount of money at a given date, while a factoring arrangement involves a company selling its accounts receivable to a third party at a discount to get cash quickly.

Question 12

The maturities of commercial paper generally range from:

Accepted Answer

Commercial paper typically has maturities that range from one month to nine months. This allows for flexibility in short-term borrowing for companies in need of quick cash flow solutions.

Question 13

Which of the following is a correct statement about commercial paper?

Accepted Answer

Commercial paper is an unsecured, short-term debt instrument issued by corporations, typically used for the financing of payroll, accounts payable, and inventories, and meeting other short-term liabilities. Its use is indeed limited to financially stable companies with high credit ratings because it is unsecured and thus relies heavily on the issuer's creditworthiness.

Question 14

______ are short-term liabilities, which include wages payable and taxes payable, that change spontaneously as the firm's normal operations change.

Accepted Answer

Accruals are short-term liabilities that arise spontaneously from a firm's normal operations. These can include wages payable, taxes payable, and other similar obligations. Supplier credits, corporate bonds, notes payable, and receivables are not necessarily tied to a company's normal operations and may not change as spontaneously as accruals.

Question 15

Suppose a firm purchases goods on credit with terms of 3/10, net 25. What is the cost of trade credit (APR) to the firm if it always pays its bill on Day 8 or sooner? In your computations, assume there are 360 days in a year.

Accepted Answer

If the firm pays its bill on Day 8, it takes advantage of the 3% discount offered for payment within 10 days. Therefore, the cost of trade credit is 0% since the firm is not incurring any additional cost by paying early.

Question 16

A revolving credit agreement is:

Accepted Answer

A revolving credit agreement is a formal, committed arrangement between a bank and a borrower in which the bank agrees to lend up to a specified maximum amount of funds during a designated period. It is typically used for recurring short-term liabilities, such as wages and taxes, that change spontaneously with operations.

Question 17

A(n) ______ is the amount a bank requires a borrower to maintain in its checking account as a requirement for getting a loan.

Accepted Answer

A compensating balance is the amount a bank requires a borrower to maintain in its checking account as a requirement for getting a loan. This serves as a form of collateral for the bank and ensures that the borrower has a certain level of financial stability. Options A, B, C, and E are not relevant to the concept of compensating balance.

Question 18

A(n) ______ is a type of legal claim (lien) against a firm's inventory when it is used as collateral for a loan and the goods are relatively high priced, slow moving, and easy to identify individually using serial numbers or other distinguishing characteristics.

Accepted Answer

A trust receipt is a type of legal claim against a firm's inventory that is used as collateral for a loan. The goods are often high priced, slow moving and identifiable using serial numbers or other distinguishing features. A trust receipt allows a borrower to take possession of inventory while the lender retains legal ownership until the loan is repaid. This provides the lender with security against default.

Question 19

Scarlett Linens offers credit with terms of 3/15, net 30 to its customers. These terms indicate that Scarlett allows its customers to take a:

Accepted Answer

The terms indicate that customers can take a 3% discount if they pay on or before Day 15 of the billing cycle. If they do not pay by Day 15, the entire bill is due by Day 30.

Question 20

Accruals represent a form of:

Accepted Answer

Accruals represent a form of free debt because they involve obligations that a company has incurred in the course of its operations for which it has not yet made payments, and no explicit interest is paid on these outstanding balances.

Quiz 14: Managing Short-Term Financing Liabilities