Chapter 15

All of the following are true except:

Trade credit represents inventories sold to customers. (Temporary investments are current assets that will be liquidated and not replaced within the current year, permanent investments are assets a firm expects to hold for longer than one year, compensating balance requirements increase the cost of financing.)

Which of the following sources of short-term financing is likely to have the lowest interest rate?

commercial paper

With regard to the hedging principle, which of the following would be an appropriate method to finance a minimum level of current assets required for year round operations?

common stock

An inventory loan agreement in which the inventories pledged as collateral are physically separated from the firm's other inventory and placed under the control of a third-party is called

a field warehouse agreement.

Which of the following is considered a spontaneous source of financing?

accounts payable

Which of the following sources of short-term financing is likely to have the highest interest rate?

accounts receivable loan (pledging of accounts receivable)

All of the following are likely to increase the cost of a company's short-term financing except

an increase in the company's debt rating by Moody's or Standard and Poors. (an increase in the bank's prime lending rate, an increase in the compensating balance required, taking a loan on a discount basis.)

Consolidated Industries borrows at prime plus 1.5% on its line of credit. The line requires a 15% compensating balance. If prime rate is 9%, what is the nominal APR of the line of credit?

12.4%

Boeing Corp. buys on 3/10, net 30 days. What is the nominal cost of interest if Boeing does not take advantage of the trade discount offered? Assume a 360-day year.

55.7%

The effective annual cost of not taking advantage of the 1/10, net 60 terms offered by a supplier is

7.27%.

Which of the following statements concerning liquidity and debt is true?

A firm can reduce its risk for illiquidity by shifting from short-term debt to long-term debt.

The inventory loan arrangement in which all of the borrower's inventories are used as collateral is termed a:

floating lien agreement.

Which of the following is a disadvantage of the use of current liabilities to finance assets?

greater risk of illiquidity

All of the following are potential disadvantages of short-term debt except:

short-term debt generally has a higher interest cost than long-term debt.

Accrued wages and accrued taxes are considered to be

spontaneous sources of unsecured short-term financing.

According to the hedging principle, fixed assets should not be financed with

temporary financing.

In general the greater a firm's reliance upon short-term debt or current liabilities:

the lower will be its liquidity.

Which of the following is an unsecured short-term bank loan made for a specific purpose?

transaction loan

Jones Company has a cash flow problem. The company owes its suppliers $300,000 on credit terms of 2/10 net 40, but Jones doesn't have the cash to pay during the discount period. Jones, however, can borrow the $300,000 at annual rate of 24%. Should Jones borrow the money to pay its accounts payable?

Yes, the effective cost of forgoing the discount is greater than 24%.

All of the following are potential advantages of commercial paper except

flexible repayment terms. (lower interest rates than comparable sources of short-term financing, no compensating balance requirements, ability to borrow very large amounts.)

Which of the following is not a source of unsecured short-term credit?

floating lien

Which of the following loans provide the least amount of security to the lender?

floating lien

JoLi Corp. purchases a new delivery van which is expected to increase cash flows for the next 10 years. JoLi can finance the purchase with a standard 48 month vehicle loan, or by getting a 10 year loan from the bank. According to the hedging principle, JoLi should

use the 10-year financing in order to match the cash flow stream from the asset with the financing repayments.

Which item would constitute poor collateral for an inventory loan?

vegetables

Spontaneous sources of financing include

wages payable.

A U.S. multinational corporation holds assets in Japan. Which of the following statements is most correct if the value of the Japanese yen declines relative to the dollar?

The multinational's exchange rate exposure is determined by its net exposed position, which is exposed assets minus exposed liabilities.

A floating lien, chattel mortgage, or terminal warehouse receipt have which of the following in common?

They all use inventory to secure a loan.

Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase of $20,000 today. Which of the following payment options makes the most sense as a general rule?

Either pay the bill on day 10 to get the discount, or wait until day 45.

What is the primary advantage of a firm that is able to issue commercial paper to finance its short-term assets?

Interest rates on commercial paper are generally lower than rates on bank loans.

With regard to the hedging principle, which of the following assets should be financed with current liabilities?

expansion of accounts receivable to meet seasonal demand

Which of the following actions would improve a firm's liquidity?

purchasing inventory with long-term debt

Which of the following actions would decrease a firm's liquidity?

reducing accounts receivable and buying bonds

Terminal warehouse agreements:

remove control of the inventory from the borrower.

You are working on your company's cash budget for the coming year and you believe there may be short periods of time where financing is required. Which of the following sources of short-term financing is most certain to be available when needed?

revolving credit agreement with a bank

Which of the following statements regarding a line of credit is true?

Such agreements usually cover the borrower's fiscal year.

Which of the following is not an advantage of trade credit?

The cost of forgoing the discount is less than the prime rate.

If a firm relies on short-term debt or current liabilities in financing its asset investments, and all other things remain the same, what can be said about the firm's liquidity?

The firm will be relatively less liquid.

Penn Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan compensating balance. Currently, Penn Inc. has no funds on deposit with the bank and will need the loan to cover the compensating balance as well as their other financing needs. How much will Penn Inc. need to borrow?

$312,500

The Stuart Glass Company established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement, Stuart had no deposit with the bank. Shortly after signing the agreement, Stuart needed $240,000 to pay off a note that was due. Stuart decides to borrow an amount sufficient to pay the $240,000 note and also to cover the compensating balance. How much must Stuart Glass borrow?

$320,000

As a company accounts payable manager, which of the following credit terms are most likely to entice you to take the cash discount?

1/10 net 30

Key Enterprises borrows $12,000 for a short-term purpose. The loan will be repaid after 120 days, with Key paying a total of $12,400. What is the approximate cost of credit using the APR , or annual percentage rate, calculation?

10.00%

Penn Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan compensating balance. Currently, Penn Inc. has no funds on deposit with the bank and will need the loan to cover the compensating balance as well as their other financing needs. What will be the annual percentage rate, or APR, for this financing?

10.00%

Key Enterprises borrows $12,000 for a short-term purpose. The loan will be repaid after 120 days, with Key paying a total of $12,400. What is the approximate cost of credit using the APY , or annual percentage yield, calculation?

10.34%

The Stuart Glass Company established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement, Stuart had no deposit with the bank. Shortly after signing the agreement, Stuart needed $240,000 to pay off a note that was due. It borrowed the $240,000 from the bank by drawing on the line of credit. What is the effective annual cost of credit?

10.67%

The Stuart Glass Company established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement, Stuart had no deposit with the bank. Shortly after signing the agreement, Stuart needed $240,000 to pay off a note that was due. Stuart decides to borrow an amount sufficient to pay the $240,000 note and also to cover the compensating balance. What is the effective annual cost of credit if the loan is made on a discount basis?

11.94%

Your company is able to arrange financing at either a rate of 12.75% annually, or at a rate of 12% compounded monthly. Assuming financing is needed for one year, which rate is the best?

12% compounded monthly, because the annual percentage yield is 12.68%

The Jubilee Manufacturing Company is going to issue 180-day commercial paper to raise $25 million. It anticipates a discounted interest rate of 13 percent, and dealer placement costs of approximately $60,000. What is the effective annual cost of credit to Jubilee?

14.45%

Wayne, Inc. has a line of credit with First National Bank that allows the company to borrow up to $800,000 at an interest rate of 12 percent. However, Wayne, Inc. must keep a compensating balance of 18 percent of any amount borrowed on deposit at the bank. Wayne, Inc. does not normally keep a cash balance account with First National Bank. What is the effective annual cost of credit?

14.63%

Florida Grape Growers (FGG) has a line of credit with Trust Company Bank that allows FGG to borrow up to $400,000 at an annual interest rate of 11 percent. However, FGG must keep a compensating balance of 25 percent of any amount borrowed on deposit at the Trust Company. FGG does not normally have a cash balance account with the Trust Company. What is the effective annual cost of credit?

14.67%

Benkart Tool and Die Company plans to sell $50,000,000 of 120-day commercial paper, on which it expects to pay discounted interest at a rate of 5% per year. Dealer fees are expected to be $30,000. The effective cost of credit to Benkart Tool and Die Company is

5.27%

A company that forgoes the discount when credit terms are 2/10 net 60 is essentially borrowing money from his supplier for an additional:

50 days.

The Stoney River Pennant Company uses commercial paper to satisfy part of its short-term financing requirements. Next week, it intends to sell $18 million in 90-day maturity paper on which it expects to have to pay discounted interest at an annual rate of 7 percent per annum. In addition, Stoney River expects to incur a cost of approximately $25,000 in dealer placement fees and other expenses of issuing the paper. What is the effective annual cost of credit to Stoney River?

7.7%

Bigtime Corp. is considering borrowing $15,000 for a 60-day period. The firm will repay the $15,000 principal amount plus $200 in interest. What is the effective annual rate of interest? Use a 360-day year.

8.0%

Assume that Billings, Inc. borrows $5,000,000 for 120 days. The total interest paid is $150,000. What is the APY, or Effective Annual Rate of interest that Billings pays?

9.27%

Which of the following is an advantage of the use of current liabilities to finance assets?

Both more flexibility and lower interest costs

Which of the following is not true regarding the use of short-term debt?

Interest rates are usually higher on short-term debt.

Interest costs for short-term debt are generally lower than interest costs for long-term debt because

both the term structure of interest rates generally reflects an upward sloping yield curve and short-term debt is more flexible, allowing a match of short-term needs with short-term financing.

Permanent sources of financing include all but

commercial paper. (corporate bonds, common stock, preferred stock)

A company that forgoes the discount when credit terms are 2/10 net 60 due to insufficient cash flow would be better off to borrow funds and take the discount as long the company could borrow the funds at any rate:

less than 14.69%.

A company that increases its liquidity by holding more cash and marketable securities is

likely to achieve a lower return on equity because of the smaller rates of return earned on cash and marketable securities compared to the firm's other investments.

According to the hedging principle, plant and equipment should be financed with

long-term funds.

In the context of managing working capital, the hedging principle refers to which of the following?

matching the maturity of the source of financing to the cash flow generating characteristics of the asset being financed.

Which of the following actions would improve a firm's liquidity?

selling bonds and increasing cash

Trade credit is an example of which of the following sources of financing?

spontaneous

The primary advantage that pledging accounts receivable provides is:

the flexibility it gives to the borrower.

Selection of a source of short-term financing should include all of the following except:

the floatation costs for debentures. (the effective cost of credit, the availability of financing in the amount and for the time needed, the effect of the use of credit from a particular source on the cost and availability of other sources of credit.)

The terminal warehouse agreement differs from the field warehouse agreement in that:

the terminal agreement transports the collateral to a public warehouse.