Deck 15: Current Liabilities Management

Question 1

A firm should take the cash discount if the firm's cost of borrowing from the bank is greater than the cost of giving up a cash discount.

Answer 1

False

Question 2

Notes payable can be either spontaneous secured or spontaneous unsecured financing and result from the normal operations of the firm.

Answer 2

False

Question 3

Spontaneous unsecured financing has a specific interest cost associated with it that can be at a fixed or floating rate.

Answer 3

False

Question 4

Spontaneous liabilities such as accounts payable and notes payable represent a source of financing that arise from the normal course of business.

Question 5

In credit terms, EOM (End-of-Month) indicates that the accounts payable must be paid by the end of the month in which the merchandise has been purchased.

Question 6

Spontaneous liabilities such as accounts payable and accruals represent a use of financing that arise from the normal course of business.

Question 7

Generally as sales increase a company needs more inventory and more employees resulting in

A) more accounts payable and accruals, and therefore increasing its spontaneous financing.
B) less accounts payable and accruals ,and therefore decreasing its spontaneous financing.
C) more accounts payable and accruals, and therefore decreasing its spontaneous financing.
D) less accounts payable and accruals ,and therefore increasing its spontaneous financing.

Question 8

The cost of giving up a cash discount is the implied rate of interest paid in order to delay payment of an account payable for an additional number of days.

Question 9

The two major sources of short-term financing are

A) a line of credit and accounts payable.
B) accounts payable and accruals.
C) a line of credit and accruals.
D) accounts receivable and notes payable.

Question 10

Accruals and accounts payable are ________ sources of short-term financing.

A) negotiated, secured
B) negotiated, unsecured
C) spontaneous, secured
D) spontaneous, unsecured

Question 11

Spontaneous liabilities such as accounts payable and accruals represent a source of financing that arise from the normal course of business.

Question 12

Accruals are liabilities for services received for which payment has yet to be made.

Question 13

Tangshan Mining was extended credit terms of 3/15 net 30 EOM. The cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, would be

A) 75.26%.
B) 18.56%.
C) 72.99%.
D) 37.12%.

Question 14

Accounts payable are spontaneous secured sources of short-term financing that arise from the normal operations of the firm.

Question 15

In giving up a cash discount, the amount of the discount that is given up is the interest being paid by the firm to keep its money by delaying payment for a number of days.

Question 16

Financing that arises from the normal operations of the firm is said to be

A) expected.
B) accrued.
C) spontaneous.
D) payable.

Question 17

Accounts payable result from transactions in which merchandise is purchased but no formal note is signed to show the purchaser's liability to the seller.

Question 18

For firms that are in a financial position to take a cash discount, it is generally a more financially sound decision not to take the discount if the terms offered are 2/10 net 30.

Question 19

________ are the major source of unsecured short-term financing for business firms.

A) Accounts receivable
B) Accruals
C) Notes payable
D) Accounts payable

Question 20

If a firm anticipates stretching accounts payable, its cost of giving up a cash discount is increased.

Question 21

By offering credit to customers, the firm may

A) increase the price of the good to cover its costs.
B) decrease its investment in accounts receivable.
C) decrease its investment in accounts payable.
D) decrease the cost of goods purchased.

Question 22

For firms that are in a financial position to take a cash discount, it is generally a more financially sound decision to take the discount if the terms offered are 2/10 net 30.

Question 23

A firm purchased goods with a purchase price of $1,000 and credit terms of 1/10 net 30. The firm paid for these goods on the 5th day after the date of sale. The firm must pay ________ for the goods.

A) $990
B) $900
C) $1,000
D) $1,100

Question 24

3/10 net 45 EOM translates as

A) a 10 percent cash discount may be taken if paid in three days; if no cash discount is taken, the balance is due in 45 days.
B) a 3 percent cash discount may be taken if paid in 10 days; if no cash discount is taken, the balance is due 45 days after transaction is complete.
C) a 3 percent cash discount may be taken if paid in 10 days; if no cash discount is taken, the balance is due 45 days after the end of the month.
D) a 3 percent discount may be taken on 10 percent of the purchase if the account is paid within 45 days after the end of the month.

Question 25

As part of a union negotiation agreement, the United Clerical Workers Union conceded to be paid every two weeks instead of every week. A major firm employing hundreds of clerical workers had a weekly payroll of $1,000,000 and the cost of short-term funds was 12 percent. The effect of this concession was to delay clearing time by one week. Due to the concession, the firm

A) realized an annual loss of $120,000.
B) realized an annual savings of $120,000.
C) increased its cash cycle.
D) decreased its cash turnover.

Question 26

One of the most common designations for the beginning of the credit period is

A) 2/10.
B) the date of invoice.
C) the end of the month.
D) the transaction date.

Question 27

A firm is offered credit terms of 2/10 net 45 by most of its suppliers but frequently does not have the cash available to take the discount. The firm has a credit line available at a local bank at an interest rate of 12 percent. The firm should

A) give up the cash discount, financing the purchase with the line of credit.
B) take the cash discount and pay on the 45th day after the date of sale.
C) take the cash discount and pay on the first day of the cash discount period.
D) take the cash discount, financing the purchase with the line of credit, the cheaper source of funds.

Question 28

If a firm gives up the cash discount on goods purchased on credit, the firm should pay the bill

A) as late as possible.
B) as soon as possible.
C) before the credit period ends.
D) on the last day of the credit period.

Question 29

The cost of giving up a cash discount under the terms of sale 1/10 net 60 (assume a 360-day year) is

A) 7.3 percent.
B) 6.1 percent.
C) 14.7 percent.
D) 12.2 percent.

Question 30

A firm is offered credit terms of 1/10 net 45 EOM by a major supplier. The firm has determined that it can stretch the credit period (net period only) by 25 days without damaging its credit standing with the supplier. Assuming the firm needs short-term financing and can borrow from the bank on a line of credit at an interest rate of 14 percent, the firm should

A) give up the cash discount and finance the purchase with the line of credit.
B) give up the cash discount and pay on the 70th day after the date of sale.
C) take the cash discount and pay on the first day of the cash discount period.
D) take the cash discount and finance the purchase with the line of credit, the cheaper source of funds.

Question 31

A firm purchased goods on January 27 with a purchase price of $1,000 and credit terms of 2/10 net 30 EOM. The firm paid for these goods on February 9. The firm must pay ________ for the goods.

A) $1,000
B) $980
C) $800
D) $900

Question 32

Tangshan Mining was extended credit terms of 3/15 net 30 EOM. The cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, is 75.26 percent. If the firm were able to stretch its accounts payable to 60 days without damaging its credit rating, the cost of giving up the cash discount would only be

A) 18.81%.
B) 18.25%.
C) 21.90%.
D) 25.09%.

Question 33

If the firm decides to take the cash discount that is offered on goods purchased on credit, the firm should

A) pay as soon as possible.
B) pay on the last day of the credit period.
C) take the discount no matter when the firm actually pays.
D) pay on the last day of the discount period.

Question 34

If a firm anticipates stretching accounts payable, its cost of giving up a cash discount is reduced.

Question 35

________ are liabilities for services received for which payment has yet to be made. The most common accounts are taxes and wages.

A) Notes payable
B) Accruals
C) Accounts payable
D) Accounts receivable

Question 36

The cost of giving up a cash discount on a credit purchase is

A) added on to the price of the goods.
B) deducted from the price of the goods.
C) the implied interest rate paid in order to delay payment for an additional number of days.
D) the true purchase price of the goods.

Question 37

When a firm stretches accounts payable without hurting its credit rating, the cost of foregoing the cash discount is

A) reduced.
B) increased.
C) unaffected.
D) immaterial.

Question 38

1/15 net 30 date of invoice translates as

A) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due in 30 days after the middle of the month.
B) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days after the invoice date.
C) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days after the end of the month.
D) a 1 percent discount may be taken on 15 percent of the purchase if the account is paid within 30 days after the end of the month.

Question 39

If possible, it would be a more financially sound decision to pay employees once every two weeks rather than once a month.

Question 40

Tangshan Mining was extended credit terms of 3/15 net 30 EOM. The cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, would be ________. If the firm were able to stretch its accounts payable to 60 days without damaging its credit rating, the cost of giving up the cash discount would only be ________.

A) 72.99%; 18.81%
B) 72.99%; 18.25%
C) 75.25%; 21.90%
D) 75.26%; 25.09%

Question 41

The discount rate is the lowest rate of interest charged by the nation's leading banks on business loans to their most important and reliable business borrowers.

Question 42

The major attraction of a line of credit from the bank's point of view is that it eliminates the need to examine the credit worthiness of a customer each time it borrows money.

Question 43

A revolving credit agreement is a form of financing consisting of short-term, unsecured promissory notes issued by firms with a high credit standing.

Question 44

Operating change restrictions are contractual restrictions that a bank may impose on a firm as part of a line of credit agreement.

Question 45

A line of credit is an agreement between a commercial bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time.

Question 46

Unlike the spontaneous sources of unsecured short-term financing, bank loans are negotiated and result from deliberate actions taken by the financial manager.

Question 47

Although more expensive than a line of credit, a revolving credit agreement can be less risky from the borrower's viewpoint.

Question 48

Under a line of credit agreement, a bank may retain the right to revoke the line if any major changes occur in the firm's financial condition or operations.

Question 49

The interest rate on a line of credit is normally stated as a fixed rate-the prime rate plus a percent.

Question 50

A short-term self-liquidating loan is a secured short-term loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid.

Question 51

Self-liquidating loans are mainly invested in productive assets (i.e., fixed assets) which provide the mechanism through which the loan is repaid.

Question 52

The cost of giving up a cash discount under the terms of sale 5/20 net 120 (assume a 360-day year) is

A) 15 percent.
B) 18.9 percent.
C) 15.8 percent.
D) 20 percent.

Question 53

A single-payment note is a secured fund which can be obtained from a commercial bank when a borrower needs additional funds for a short period.

Question 54

Under a line of credit agreement, a bank may require an annual cleanup, which means that the borrower must pay off all its outstanding debts to all lenders for a certain number of days during the year.

Question 55

The prime rate of interest fluctuates with changing supply-and-demand relationships for short-term funds as well as the risk of the bank's business borrowers.

Question 56

Ashley's Delivery Service is analyzing the credit terms of each of three suppliers, A, B, and C. (a) Determine the approximate cost of giving up the cash discount.
(b) Assuming the firm needs short-term financing, recommend whether or not the firm should give up the cash discount or borrow from the bank at 10 percent annual interest. Evaluate each supplier separately.

Question 57

Self-liquidating loans are intended merely to carry the firm through seasonal peaks in financing needs, mainly buildups of accounts receivable and inventory.

Question 58

The effective interest rate on a bank loan depends on whether interest is paid when the loan matures or in advance.

Question 59

A discount loan is a loan on which interest is paid in advance by deducting it from the loan so that the borrower actually receives less money than is requested.

Question 60

Generally the increment above the prime rate on a floating-rate loan will be higher than on a fixed-rate loan of equivalent risk because the lender bears higher risk with a floating-rate loan.

Question 61

The effective interest rate for a discount loan is greater than the loan's stated interest rate.

Question 62

Cull Incorporated recently borrowed $250,000 from Century Bank when the prime rate was 4%. The loan was for 90 days with interest to be paid at the end of the period with a rate fixed at 1.5% above the prime rate. What is the total interest paid on this loan and what is the effective annual rate? (Assume a 365 day year.)

A) The total interest paid is $3390.41 and the effective annual rate is 5.62%.
B) The total interest paid is $13,750 and the effective annual rate is 5.62%.
C) The total interest paid is $13,750 and the effective annual rate is 5.55%.
D) The total interest paid is $3390.41 and the effective annual rate is 1.36%.

Question 63

Revolving credit agreements are non-guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Question 64

Lines of credit are guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Question 65

The major type of loan made by banks to businesses is the

A) fixed-asset-based loan.
B) short-term secured loan.
C) short-term self-liquidating loan.
D) capital improvement loan.

Question 66

Tangshan Mining borrowed $10,000 for one year under a revolving credit agreement that authorized and guaranteed the firm access to $20,000. The revolving credit agreement had a stated interest rate of 8 percent and charged the firm a half percent commitment fee on the unused portion of the agreement. Based on this information, the effective annual interest rate on the loan was 9.50 percent.

Question 67

If one borrows $1,000 at 8 percent interest on a discount basis, the effective rate of interest is about 9.7 percent.

Question 68

A compensating balance, which is a required checking account balance equal to a certain percentage of the borrower's short-term unsecured loan, may not only forces the borrower to be a good customer of the bank but may also raise the interest cost to the borrower, thereby increasing the bank's earnings.

Question 69

Revolving credit agreements are guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Question 70

A ________ is a type of loan made to a business by a commercial bank. This type of loan is made when the borrower needs additional funds for a short period but does not believe the need will continue or reoccur on a seasonal basis.

A) revolving credit agreement
B) line of credit
C) short-term self-liquidating loan
D) single payment note

Question 71

A fixed-rate loan is a loan whose rate of interest is established at a fixed increment above the prime rate and is allowed to vary above prime only when the prime rate varies until maturity.

Question 72

If one borrows $1,000 at 8 percent interest on a discount basis, the effective rate of interest is about 8.7 percent.

Question 73

Lines of credit are non-guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Question 74

Short-term loans that businesses obtain from banks and through commercial paper are

A) negotiated and secured.
B) negotiated and unsecured.
C) spontaneous and secured.
D) spontaneous and unsecured.

Question 75

If possible, it would be a more financially sound decision to pay employees once a month rather than once every two weeks.

Question 76

Tangshan Mining borrowed $10,000 for one year under a line of credit with a stated interest rate of 8 percent and a 10 percent compensating balance. Normally, the firm keeps almost no money in its checking account. Based on this information, the effective annual interest rate on the loan was 8.89 percent.

Question 77

Tangshan Mining borrowed $10,000 for one year under a line of credit with a stated interest rate of 8 percent and a 10 percent compensating balance. Normally, the firm keeps a balance of about $800 in its checking account. Based on this information, the effective annual interest rate on the loan was 8.89 percent.

Question 78

The ________ is the lowest rate of interest charged on business loans to the best business borrowers by the nation's leading banks.

A) prime rate
B) commercial paper rate
C) federal funds rate
D) treasury bill rate

Question 79

Tangshan Mining borrowed $10,000 for one year under a revolving credit agreement that authorized and guaranteed the firm access to $20,000. The revolving credit agreement had a stated interest rate of 8 percent and charged the firm a half percent commitment fee on the unused portion of the agreement. Based on this information, the effective annual interest rate on the loan was 8.50 percent.

Question 80

Short-term self-liquidating loans are intended to

A) finance capital assets.
B) cover seasonal peaks in financing caused by inventory and receivable buildups.
C) finance merger/acquisition activity.
D) recapitalize the firm.