Question 1

What credit decision is appropriate for a potential customer that offers a 75% chance of paying on a $10,000 sale which has an 80% cost?
A) Grant credit since the expected profit is $3,200.
B) Grant credit since the expected profit is $800.
C) Refuse credit since the expected profit is negative.
D) Refuse credit since the expected loss is zero.

Accepted Answer

Expected profit from offering credit = 0.75 × PV($10,000 − 8,000) − 0.25 × PV($8,000) < $0

Question 2

What is the cash cycle for a firm with $3 million average inventories,$1.5 million average accounts payable,a receivables period of 40 days,and annual sales of $20 million and an annual cost of goods sold of $18 million?
A) 14.59 days.
B) 46.25 days.
C) 136.25 days.
D) 70.42 days.

Accepted Answer

Cash conversion cycle = $3m / ($18m / 365) + 40 − $1.5m / ($18m / 365) = 70.42 days

Question 3

Which one of the following credit agreements provides the least protection to the seller?
A) Banker's acceptance
B) Time draft
C) Open account
D) Commercial draft

Accepted Answer

An open account is an agreement in which the seller agrees to ship goods to the buyer with the expectation of payment at a later date. This type of credit agreement provides the least protection to the seller because the goods are shipped without any formal payment agreement in place. The seller is relying solely on the buyer's promise to pay at a later date. In contrast, banker's acceptances, time drafts, and commercial drafts all provide some form of financial guarantee or formal payment agreement that provides more protection to the seller.

Question 4

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 following month. D) The discount period ends either 10 days after invoicing or at the end of the month, whichever is earlier.

Accepted Answer

The terms "4/10, EOM, net 90" mean a 4% discount is available if paid within 10 days after the end of the month (EOM), and the full invoice is due 90 days after the end of the month.

Question 5

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.

Accepted Answer

Credit scoring systems are used to evaluate the credit risk based on the borrower's characteristics, which can include factors such as credit history, income, and employment status. This information helps lenders determine the likelihood that a borrower will pay back a loan and can inform decisions about interest rates, loan amounts, and other terms of the loan.

Question 6

What is the daily net cost of holding a cash balance of $2.5 million,if the daily interest rate is 0.025% and the average transaction cost of investing money overnight is $50?
A) $121
B) $171
C) $575
D) $675

Accepted Answer

Net opportunity cost = (0.00025 × $2.5m) − $50 = $575

Question 7

Which one of the following is not included in the five Cs of credit?
A) Character
B) Condition
C) Consumption
D) Capital

Accepted Answer

The five Cs of credit include Character, Capacity, Capital, Collateral, and Condition. Consumption is not included in the five Cs.

Question 8

The set of rules that determines whether or not credit should be extended is known as:
A) credit analysis.
B) credit policy.
C) multiple discriminate analysis.
D) the terms of trade credit.

Accepted Answer

Credit policy refers to the set of criteria used to determine whether or not to extend credit to a particular customer. It typically includes guidelines for assessing the creditworthiness of a customer, as well as the terms and conditions under which credit will be extended. Credit analysis (A) is a component of credit policy that involves evaluating the financial and credit history of a customer. Multiple discriminate analysis (C) is a statistical technique used in credit analysis to predict the likelihood of default. The terms of trade credit (D) refer to the specific payment terms and conditions agreed upon for a particular credit transaction, which are often determined by the credit policy.

Question 9

Which one of the following would not be a customary source of credit information on customers?
A) Dun and Bradstreet
B) Chamber of Commerce
C) Credit Bureau
D) Customer's bank

Accepted Answer

While the Chamber of Commerce may provide networking opportunities and other resources for businesses, it is not typically a source of credit information on customers. The other options listed are all common sources of credit information.

Question 10

A $1,200 invoice dated January 1 has credit terms of 3/10,net 30.If the buyer pays January 4,how much will he need to pay?
A) $1,164
B) $1,080
C) $900
D) $1,200

Accepted Answer

Discounted payment = (1 − 0.03) × $1,200 = $1,164

Question 11

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 a week.

Accepted Answer

Money market securities typically have a maturity of less than one year, making them a short-term investment option for investors. This includes treasury bills, commercial paper, certificates of deposit, and other similar instruments. Options A and C are incorrect because they suggest longer maturities, while option D is incorrect because it suggests an extremely short maturity, which is not typical of money market securities.

Question 12

Which one of the following statements typically describes the break-even probability of collection for repeat sale customers?
A) The break-even probability is higher than for single sale customers.
B) The break-even probability is lower than for single sale customers.
C) The break-even probability does not change between single sale and repeat sale customers.
D) Sales should never be refused for customers offering the potential of repeat sales.

Accepted Answer

Repeat sale customers are more likely to make additional purchases in the future, thus decreasing the break-even probability compared to single sale customers. This means that the initial cost of acquiring the customer is spread over multiple purchases, making it easier to break even and generate profit.

Question 13

Firms should be more prepared to sell on credit to high-risk customers if:
A) the profit margin is low.
B) the probability of repeat orders is low.
C) the profit margin is high.
D) the firm's sales representative is paid on commission.

Accepted Answer

Firms may be more willing to sell on credit to high-risk customers if the profit margin is high, as the potential for higher profits can offset the risk of non-payment.

Question 14

An aging schedule illustrates the relationship between:
A) the time history with a customer and the number of repeat sales.
B) the average sale size and profitability over time.
C) customer ages and the average size of sales.
D) an accounts receivable and its time outstanding.

Accepted Answer

An aging schedule tracks accounts receivable and the length of time they have been outstanding. It is used to manage cash flow and identify potential bad debts.

Question 15

Which of the following strategies should a cash-strapped firm adopt if 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.

Accepted Answer

The answer of Which of the following strategies should a...

Question 16

If goods are sold on terms of 5/10,net 90,what effective interest rate is if the purchaser pays on day 90?
A) 20.00%
B) 22.81%
C) 24.93%
D) 26.37%

Accepted Answer

EAR = [1 + (0.05 / (1 − 0.05))]^{365 / (90 − 10)} − 1 = 0.2637, or 26.37%

Question 17

The purpose of credit analysis is to:
A) reconcile the accounts receivable balance.
B) modify the terms of trade credit.
C) organize the right side of the balance sheet.
D) decide whether or not to grant credit to a customer.

Accepted Answer

The purpose of credit analysis is to evaluate the creditworthiness of potential or existing customers and determine whether or not to grant credit. This involves assessing their financial stability, credit history, and ability to repay debts. Choices A, B, and C involve other financial tasks, but they do not specifically relate to the evaluation of creditworthiness.

Question 18

Which one of the following changes to the terms of credit would increase the effective annual interest rate charged?
A) Increasing the cash discount percentage
B) Extending the discount period and payment period by 10 days each
C) Extending the payment period only
D) Decreasing the discount period only

Accepted Answer

The answer of Which one of the following changes to...

Question 19

Which one of the following is most likely to discourage purchasers from taking a discount?
A) A higher discount percentage
B) A shorter payment period
C) A longer discount period
D) A longer payment period

Accepted Answer

A longer payment period means purchasers have more time to pay the full invoice amount, which may make them less likely to be motivated by a discount.

Question 20

What is the expected payoff on a $2,000 sale that has a 30% profit margin if there is a 20% probability of default?
A) $1,000
B) $120
C) $600
D) $200

Accepted Answer

Expected payoff = 0.8 × 0.3 × $2,000 − (0.2 × 0.70 × $2,000) = $200

Quiz 20: Working Capital Management

What credit decision is appropriate for a potential customer that offers a 75% chance of paying on a $10,000 sale which has an 80% cost?

What is the cash cycle for a firm with $3 million average inventories,$1.5 million average accounts payable,a receivables period of 40 days,and annual sales of $20 million and an annual cost of goods sold of $18 million?

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

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

Credit scoring systems can be used to:

What is the daily net cost of holding a cash balance of $2.5 million,if the daily interest rate is 0.025% and the average transaction cost of investing money overnight is $50?

Which one of the following is not included in the five Cs of credit?

The set of rules that determines whether or not credit should be extended is known as:

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

A $1,200 invoice dated January 1 has credit terms of 3/10,net 30.If the buyer pays January 4,how much will he need to pay?

Money market securities usually have a maturity of:

Which one of the following statements typically describes the break-even probability of collection for repeat sale customers?

Firms should be more prepared to sell on credit to high-risk customers if:

An aging schedule illustrates the relationship between:

Which of the following strategies should a cash-strapped firm adopt if the effective interest rate charged on trade credit is lower than the bank's interest rate?

If goods are sold on terms of 5/10,net 90,what effective interest rate is if the purchaser pays on day 90?

The purpose of credit analysis is to:

Which one of the following changes to the terms of credit would increase the effective annual interest rate charged?

Which one of the following is most likely to discourage purchasers from taking a discount?

What is the expected payoff on a $2,000 sale that has a 30% profit margin if there is a 20% probability of default?