Deck 20: Short-Term Financial Planning

Question 1

Azamel Cosmetics specializes in cosmetics which have high levels of UV protection. The above figures show the anticipated sales over the next four quarters. Azamel carries inventory equal to 30% of next quarter's sales, has accounts payable of 20% of next quarter's sales, and accounts receivable of 25% of this quarter's sales. If its net income is 12% of sales, in which quarter will Azamel's seasonal working capital needs will be the greatest?

A) Q1
B) Q2
C) Q3
D) Q4

Answer 1

Q3

Question 2

Glenside Industries is a domestic machinery manufacturer which specializes in the production of snowblowers. The above figures show the anticipated sales over the next four quarters. Glenside carries inventory equal to 25% of next quarter's sales, has accounts payable of 15% of next quarter's sales, and accounts receivable of 23% of this quarter's sales. If its net income is 10% of sales, in which quarter is it expected that Glenside's seasonal working capital needs will be the greatest?

A) Q1
B) Q2
C) Q3
D) Q4

Answer 2

Q3

Question 3

Which of the following companies has the smallest need for short-term financial planning?

A) a company that produces Christmas decorations.
B) a toy manufacturer.
C) a company that makes condiments such as ketchup.
D) a company that provides catering services for weddings.

Answer 3

a company that makes condiments such as ketchup.

Question 4

Cash flow forecasts are conducted in order to determine whether a firm has a cash flow surplus or deficit and whether such a surplus or deficit is temporary or permanent.

Question 5

Use the table for the question(s) below.
The quarterly working capital levels for Fancy Weddings Inc. are presented in the following table (in $ millions):

In which quarter are Fancy's seasonal working capital needs the smallest?

A) 1
B) 2
C) 3
D) 4

Question 6

Which of the following companies is most likely to have the greatest need for short-term financial planning?

A) a company that mines sand for use in glass-making
B) a company that manufacturers condiments such as ketchup
C) a company that produces advertisements for roadside billboards
D) a company that provides catering services for weddings

Question 7

Which of the following firms is likely to have the highest short-term financing needs?

A) a pharmaceutical manufacturer
B) a grocery store
C) an electric utility
D) a toy store

Question 8

Which of the following are the three reasons that firms need short-term financing?

A) seasonalities, permanent working capital, and positive cash flow shocks
B) seasonalities, funding risk, and permanent working capital
C) negative cash flow shocks, positive cash flow shocks, and seasonalities
D) permanent working capital, negative cash flow shocks, and funding risk

Question 9

What do we understand by seasonality?

Question 10

Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $ millions):

In which quarter are Hasbeen's seasonal working capital needs the greatest?

A) 1
B) 2
C) 3
D) 4

Question 11

Occasionally, a company will encounter circumstances in which cash flows are temporarily negative for an unexpected reason. We refer to such a situation as a ________.

A) liquidity shock
B) negative cash flow shock
C) negative liquidity shock
D) cash crunch

Question 12

A company that makes decorations for Christmas trees has high sales in its fourth quarter but very low sales during the rest of the year. It manufactures decorations steadily throughout the year, however. Which of the following is NOT a likely consequence of this scenario?

A) The firm will need sources of short-term cash to fund inventory in the second and third quarters.
B) The firm will see negative net cash flows in the second and third quarter.
C) The firm will have a large short-term surplus in the fourth quarter.
D) Accounts payables will rise from the first to fourth quarter.

Question 13

Firms need short-term financing to deal with seasonal working capital requirements, negative cash flow shocks, or positive cash flow shocks.

Question 14

How does seasonality create fluctuations in a firm's net income over a year?

A) Cost of goods sold will rise and fall along with sales, while administrative and other costs will remain relatively steady.
B) Cost of goods sold will rise when sales fall, and vice versa, while administrative and other costs will remain relatively steady.
C) Cost of goods sold, along with administrative and other costs, will rise when sales fall, and vice versa.
D) Cost of goods sold, along with administrative and other costs, will rise and fall along with sales.

Question 15

Use the table for the question(s) below.
The quarterly working capital levels for Fancy Weddings Inc. are presented in the following table (in $ millions):

In which quarter are Fancy's seasonal working capital needs the greatest?

A) 1
B) 2
C) 3
D) 4

Question 16

What do we understand by negative cash flow shocks?

Question 17

Which of the following statements is FALSE?

A) Firms with seasonal cash flows may find themselves with a surplus of cash during some months that is sufficient to compensate for a shortfall during other months. However, because of timing differences, such firms often have short-term financing needs.
B) A company forecasts its cash flows to determine whether it will have surplus cash or a cash deficit for each period.
C) Positive cash flow shocks cannot create short-term financing needs.
D) When sales are concentrated during a few months, sources and uses of cash are also likely to be seasonal.

Question 18

When a company analyzes its short-term financing needs, it typically examines cash flows at ________.

A) monthly intervals
B) yearly intervals
C) quarterly intervals
D) weekly intervals

Question 19

Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $ millions):

In which quarter are Hasbeen's seasonal working capital needs the smallest?

A) 1
B) 2
C) 3
D) 4

Question 20

Which of the following statements is FALSE?

A) If a company anticipates an ongoing surplus of cash, it may choose to increase its dividend payout.
B) Seasonal sales can create large short-term cash flow deficits and surpluses.
C) The first step in short-term financial planning is to forecast the company's future net working capital.
D) Deficits resulting from investments in long-term projects are often financed using long-term sources of capital, such as equity or long-term bonds.

Question 21

Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $ millions):

The permanent working capital needs for Hasbeen Toys is closest to ________.

A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million

Question 22

What do we understand by positive cash flow shocks?

Question 23

Which of the following statements is FALSE?

A) Because investment in permanent working capital is required so long as the firm remains in business, it constitutes a long-term investment.
B) Because temporary working capital represents a short-term need, the firm should finance this portion of its investment with short-term financing.
C) Temporary working capital is the difference between the lowest level of investment in short-term assets and the permanent working capital investment.
D) The matching principle states that short-term needs should be financed with short-term debt and long-term needs should be financed with long-term sources of funds.

Question 24

Which of the following statements is FALSE?

A) When following a conservative financing policy, a firm would use long-term sources of funds to finance its fixed assets, permanent working capital, and some of its seasonal needs.
B) An aggressive financing policy also increases the possibility that managers of the firm will use this excess cash nonproductively-for example, on perquisites for themselves.
C) A firm could finance its short-term needs with long-term debt, a practice known as a conservative financing policy.
D) To implement a conservative financing policy effectively, there will necessarily be periods when excess cash is available-those periods when the firm requires little or no investment in temporary working capital.

Question 25

Which of the following is not a specific financing option for temporary working capital?

A) secured financing
B) commercial paper
C) bank loans
D) repurchase agreements

Question 26

Use the information for the question(s) below.
The above graph shows the levels of fixed assets, permanent working capital and temporary working capital for a certain company. If the graphs below show the level of short-term debt that the firm borrows each quarter, which best illustrates an aggressive financing policy?

A)

B)

C)

D)

Question 27

What is permanent working capital?

A) the amount that a firm must keep invested in its short-term assets to support its continuing operations
B) the difference between the actual level of investment in short-term assets and the amount that a firm must keep invested in its short-term assets to support its continuing operations
C) the amount that a firm keeps invested in its short-term assets to support its continuing operations which are financed by short-term debt
D) the amount that a firm keeps invested in its short-term assets to support its continuing operations which are financed by long-term debt

Question 28

Which of the following statements is FALSE?

A) Financing part or all of the permanent working capital with short-term debt is known as an aggressive financing policy.
B) When the yield curve is downward sloping, the interest rate on short-term debt is lower than the rate on long-term debt. In that case, short-term debt may appear cheaper than long-term debt.
C) The value of short-term debt is less sensitive to the firm's credit quality than long-term debt; therefore, its value will be less affected by management's actions or information.
D) Permanent working capital is the amount that a firm must keep invested in its short-term assets to support its continuing operations.

Question 29

Which short-term financing policy states that short-term cash needs should be financed with short-term debt and long-term cash needs should be financed with long-term sources of funds?

A) aggressive policy
B) evergreen credit
C) matching principle
D) conservatism principle

Question 30

Which of the following statements regarding how a firm should finance its cash needs is true?

A) Permanent working capital should be financed by long-term sources of funds, while temporary working capital should be financed by short-term sources of funds.
B) Permanent working capital should be financed by short-term sources of funds, while temporary working capital should be financed by long-term sources of funds.
C) Both permanent working capital and temporary working capital should be financed by short-term sources of funds.
D) Both permanent working capital and temporary working capital should be financed by long-term sources of funds.

Question 31

According to the matching principle, short-term needs for funds should be financed by short-term sources of funds; long-term need for funds should be financed by long-term sources of funds.

Question 32

Use the information for the question(s) below.
The above graph shows the levels of fixed assets, permanent working capital and temporary working capital for a certain company. If the graphs below show the excess cash reserves on hand each quarter, which best illustrates a conservative financing policy?

A)

B)

C)

D)

Question 33

Which of the following statements is FALSE?

A) With a discount loan, the borrower is required to pay the interest at the end of the loan period.
B) Bridge loans are often quoted as discount loans with fixed interest rates.
C) A bridge loan is another type of short-term bank loan that is often used to "bridge the gap" until a firm can arrange for long-term financing.
D) After a natural disaster, lenders may provide businesses with short-term loans to serve as bridges until they receive insurance payments or long-term disaster relief.

Question 34

Which of the following is NOT a reason why a firm would choose to follow an aggressive financing policy?

A) to reduce sensitivity to the firm's credit quality
B) to reduce agency costs
C) to take advantage of lower interest rates
D) to reduce exposure to funding risk

Question 35

Which of the following best describes an aggressive financing policy?

A) financing part or all of the permanent working capital with short-term debt
B) financing part or all of the permanent working capital with long-term debt
C) financing part or all of the temporary working capital with short-term debt
D) financing part or all of the temporary working capital with long-term debt

Question 36

Which of the following statements is FALSE?

A) By relying on short-term debt, the firm exposes itself to funding risk, which is the risk of incurring financial distress costs if it cannot refinance its debt in a timely manner or at a reasonable rate.
B) An ultra-conservative policy would involve financing even some of the plant, property, and equipment with short-term sources of funds.
C) With a conservative financing policy, the firm would use short-term debt very sparingly to meet its peak seasonal needs.
D) Short-term debt can have lower agency and lemons costs than long-term debt, and an aggressive financing policy can benefit shareholders.

Question 37

Which of the following statements is FALSE?

A) The matching principle indicates that the firm should finance permanent working capital with short-term sources of funds.
B) Following the matching principle should, in the long run, help minimize a firm's transaction costs.
C) In a perfect capital market, the choice of financing is irrelevant; thus how the firm chooses to finance its short-term cash needs cannot affect value.
D) A portion of a firm's investment in its accounts receivable and inventory is temporary and results from seasonal fluctuations in the firm's business or unanticipated shocks.

Question 38

Bradford Maintenance, a firm which provides lawn care services, has some seasonal variations in its cash flow needs, since much of the demand for its services is in the summer months. It uses long-term sources of funds to finance its assets such as its fleet of vehicles and lawn-care equipment and for the permanent funds that it must have at all times. For its peak seasonal needs it uses long-term sources and some short-term debt. What best describes the financial policy being followed by Bradford?

A) matching
B) conservative
C) integrated
D) seasonal

Question 39

Which of the following best describes a conservative financing policy?

A) financing part or all of the permanent working capital with short-term debt
B) financing part or all of the permanent working capital with long-term debt
C) financing part or all of the temporary working capital with short-term debt
D) financing part or all of the temporary working capital with long-term debt

Question 40

What is temporary working capital?

A) the amount that a firm must keep invested in its short-term assets to support its continuing operations
B) the difference between the actual level of investment in short-term working capital needs and its permanent working capital investment
C) the amount that a firm keeps invested in its short-term assets to support its continuing operations which are financed by short-term debt
D) the amount that a firm keeps invested in its short-term assets to support its continuing operations which are financed by long-term debt

Question 41

A firm has a committed line of credit with a maximum of $10 million and an interest rate of 8.5% (EAR) with a certain bank. The commitment fee is 0.5% (EAR). The firm borrows $2 million at the start of the year and then repays it at the end of the year. What is the total cost of the loan?

A) $520,000
B) $680,000
C) $210,000
D) $720,000

Question 42

A petroleum exploration company takes a short-term bank loan in order to finance the purchase of several truck-mounted, vibroseis shakers, which have unexpectedly come onto the market at a good price. Once the purchase is made, the company will obtain long-term financing. Which of the following best describes the short-term loan the company has taken?

A) a single, end-of-period payment loan
B) a promissory note
C) a bridge loan
D) an uncommitted line of credit

Question 43

The prime rate is the rate banks charge all but their largest customers, who can negotiate a sub-prime rate.

Question 44

Which of the following bank loan arrangements is typically accompanied by a requirement that the firm maintain a minimum level of deposits with the lending bank and restricts the level of the borrowing firm's working capital?

A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit

Question 45

Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $ millions):

The temporary working capital needs for Hasbeen Toys in quarter 1 is closest to ________.

A) $0 million
B) $340 million
C) $770 million
D) $845 million

Question 46

In a single, end-of-period payment loan, firms ________.

A) pay no interest on the loan and pay back the principal in one lump sum at the beginning of the loan
B) pay no interest on the loan and pay back the principal in one lump sum at the end of the loan
C) pay interest on the loan and pay back the principal in one lump sum in the beginning of the loan
D) pay interest on the loan and pay back the principal in one lump sum at the end of the loan

Question 47

Gemini Real Estate is offered a $2 million line of credit for four months at an APR of 9%. This loan has a loan origination fee of 1.5%. What is the actual four-month interest rate paid, expressed as an EAR?

A) 4.57%
B) 9.68%
C) 12.44%
D) 14.34%

Question 48

A loan agreement that requires the firm to pay interest on the loan and pay back the principal in one lump sum at the end of the loan is called ________.

A) a short-term mortgage loan
B) a single, end-of-period-payment loan
C) a bridge loan
D) a line of credit

Question 49

What is permanent working capital?

Question 50

Which of the following best describes a bank loan arrangement where a bank agrees to lend a firm any amount up to a stated maximum in an informal agreement which does not legally bind the bank to provide the funds?

A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit

Question 51

A firm has a committed line of credit with a maximum of $1.2 million and an interest rate of 12% (EAR) with a certain bank. The commitment fee is 0.6% (EAR). The firm borrows $500,000 at the start of the year and then repays it at the end of the year. What is the total cost of the loan?

A) $60,000
B) $64,200
C) $76,300
D) $95,000

Question 52

Jim's Electrical is offered a $400,000 line of credit for six months at an APR of 9%. The bank requires that the firm keep an amount equal to 5% of the loan principal in a non-interest-earning account with the bank as long as the loan remains outstanding. What is the actual six-month interest rate paid, expressed as an EAR?

A) 3.2%
B) 5.0%
C) 9.70%
D) 24.3%

Question 53

What is temporary working capital?

Question 54

Conways Roofing Services is offered a $1 million line of credit for three months at an APR of 8%. The bank requires that the firm keep an amount equal to 12% of the loan principal in a non-interest-earning account with the bank as long as the loan remains outstanding. What is the actual three-month interest rate paid, expressed as an EAR?

A) 9.41%
B) 24.40%
C) 60.30%
D) 80.40%

Question 55

A firm has a committed line of credit with a maximum of $2.5 million and an interest rate of 9% (EAR) with a certain bank. The commitment fee is 0.65% (EAR). The firm borrows $2 million at the start of the year, and then repays it at the end of the year. What is the total cost of the loan?

A) $180,000
B) $183,250
C) $193,000
D) $212,500

Question 56

Which of the following is a committed line of credit with no fixed maturity?

A) a bridge loan
B) evergreen credit
C) a promissory note
D) a blanket lien

Question 57

Crimini Foods is offered a $400,000 line of credit for six months at an APR of 10%. This loan has a loan origination fee of 2%. What is the actual six-month interest rate paid, expressed as an EAR?

A) 7.14%
B) 10.60%
C) 11.03%
D) 14.80%

Question 58

Stuart Mining is offered a $4,000,000 line of credit for three months at an APR of 6%. The bank requires that the firm keep an amount equal to 10% of the loan principal in an account with the bank as long as the loan remains outstanding. This account pays 2% APR with quarterly compounding. What is the actual three-month interest paid on this loan?

A) 1.6%
B) 6.6%
C) 12.6%
D) 14.6%
E) 60.9%

Question 59

Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $ millions):

The temporary working capital needs for Hasbeen Toys in quarter 3 is closest to ________.

A) $845 million
B) $0 million
C) $770 million
D) $340 million

Question 60

An uncommitted line of credit is obtained through a nonbinding, informal agreement.

Question 61

What is the maximum maturity of commercial paper?

A) 60 days
B) 90 days
C) 180 days
D) 270 days

Question 62

A firm issues two-month commercial paper with $1,000,000 face value and receives $985,000. What is the EAR the firm is paying for these funds?

A) 1.52%
B) 7.50%
C) 9.49%
D) 15.00%

Question 63

What is single, end-of-period payment loan?

Question 64

Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. If this loan has an origination fee of 1%, then the effective annual rate (EAR) for this loan is closest to ________.

A) 12.0%
B) 12.6%
C) 4.1%
D) 13.8%

Question 65

Which of the following statements is FALSE?

A) Bank loans are typically initiated with a promissory note, which is a written statement that indicates the amount of the loan, the date payment is due, and the interest rate.
B) The most straightforward type of bank loan is a single, end-of-period-payment loan.
C) With a fixed interest rate, the specific rate that the bank will charge is stipulated at the time the loan is made.
D) One of the primary sources of short-term financing, especially for small businesses, is the investment bank.

Question 66

A firm issues three-month commercial paper with $200,000 face value and receives $192,000. What is the EAR the firm is paying for these funds?

A) 5.24%
B) 8.00%
C) 16.00%
D) 17.74%

Question 67

Which of the following statements is FALSE?

A) The prime rate is the rate banks charge other banks.
B) With a variable interest rate, the terms of the loan may indicate that the rate will vary with some spread relative to a benchmark rate, such as the yield on one-year Treasury securities or the prime rate.
C) With a discount loan, the borrower is required to pay the interest at the beginning of the loan period.
D) A common benchmark rate is the London Inter-Bank Offered Rate, or LIBOR, which is the rate of interest at which banks borrow funds from each other in the London interbank market.

Question 68

The interest on commercial paper is typically paid by selling it at an initial discount.

Question 69

Ultimate Industries issues commercial paper with a face value of $500,000 and a maturity of six months. Ultimate receives net proceeds of $486,000 when it sells the paper. If the prime rate is 8.5% APR compounded quarterly, how much savings in interest did Ultimate realize by accessing the commercial paper market?

A) $4,248
B) $6,874
C) $7,291
D) $12,480

Question 70

Which of the following statements is FALSE?

A) Regardless of the loan structure, the bank may include a compensating balance requirement in the loan agreement that reduces the usable loan proceeds.
B) A common type of fee is a loan origination fee, which a bank charges to cover credit checks and legal fees.
C) Firms frequently use lines of credit to finance seasonal needs.
D) The commitment fee associated with a committed line of credit is designed to decreases the effective cost of the loan to the firm.

Question 71

Luther Industries is offered a $1 million loan for four months at an APR of 9%. If Luther's bank requires that the firm maintain a compensating balance equal to 10% of the loan amount in a non-interest-earning account, then the effective annual rate EAR for this loan is closest to ________.

A) 10.3%
B) 12.6%
C) 14.4%
D) 71.5%

Question 72

What are loan origination fees and what effect does it have on the loan?

Question 73

What are commitment fees and what effect does it have on the loan?

Question 74

Which of the following statements regarding lines of credit is FALSE?

A) The line of credit agreement may also stipulate that at some point in time the outstanding balance must be zero. This policy ensures that the firm does not use the short-term financing to finance its long-term obligations.
B) A revolving line of credit is an uncommitted line of credit that involves an informal agreement from the bank for a longer period of time, typically two to three years.
C) The line of credit may be uncommitted, meaning it is an informal agreement that does not legally bind the bank to provide the funds.
D) A revolving line of credit with no fixed maturity is called evergreen credit.

Question 75

A short-term bank loan that is often used until a firm can arrange for long-term financing is called ________.

A) a committed line of credit
B) a short-term mortgage loan
C) a bridge loan
D) a single, end-of-period-payment loan

Question 76

A written, legally binding agreement that obligates the bank to lend a firm any amount up to a stated maximum, regardless of the financial condition of the firm (unless the firm is bankrupt) as long as the firm satisfies any restrictions in the agreement is called ________.

A) a bridge loan
B) a single, end-of-period-payment loan
C) a short-term mortgage loan
D) a committed line of credit

Question 77

A firm issues six-month commercial paper with $500,000 face value and receives $488,000. What is the EAR the firm is paying for these funds?

A) 2.40%
B) 2.45%
C) 4.98%
D) 6.00%

Question 78

Commercial paper is rated by credit rating agencies.

Question 79

Commercial paper is usually a more expensive source of funds than a short-term bank loan.

Question 80

What are compensating balance and what effect does it have on the loan?