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Finance
Q:
The hedging principle involves matching the cash flow from an asset with the cash flow requirements of the financing used.
Q:
Minimum levels of inventory and accounts receivable that will be maintained throughout the year are current assets, and therefore considered temporary investments.
Q:
Total assets must always equal the sum of temporary, permanent, and spontaneous sources of financing.
Q:
One example of the hedging principle is to reduce a company's foreign exchange risk by purchasing futures contracts, which are called hedges.
Q:
The hedging principle is used to address the issue of how much short-term financing a firm should use.
Q:
The hedging principle involves the use of hedge funds to manage the firm's working capital.
Q:
Accrued taxes and salaries payable are both sources of spontaneous financing.
Q:
The hedging principle is also called the principle of self-liquidating inventory.
Q:
How does the use of current liabilities enhance profitability and also increase the firm's risk of default on its financial obligations?
Q:
Discuss the risk-return trade-off experienced in working-capital management.
Q:
Selection of a source of short-term financing should include all of the following EXCEPT
A) the effective cost of credit.
B) the availability of financing in the amount and for the time needed.
C) the floatation costs for debentures.
D) the effect of the use of credit from a particular source on the cost and availability of other sources of credit.
Q:
Working capital includes all of the following EXCEPT
A) cash.
B) accounts receivable.
C) accounts payable.
D) inventories.
Q:
Net working capital refers to which of the following?
A) cash, accounts receivable, and inventory
B) notes payable, accruals, and accounts payable
C) current assets plus current liabilities
D) current assets divided by current liabilities
E) current assets minus current liabilities
Q:
Which of the following is an advantage of utilizing short-term debt to finance the acquisition of short-term assets?
A) Interest rates on short-term debt are usually lower than interest-rates on long-term debt.
B) It exposes the firm to less risk than if the firm were to use long-term debt.
C) It improves the firm's debt ratio.
D) It increases the firm's sustainable growth rate.
Q:
The risk-return trade-off in managing a firm's working capital involves which of the following?
A) a trade-off between liquidity and activity
B) a trade-off between debt and equity
C) a trade-off between the firm's liquidity and its profitability
D) none of the above
Q:
Which of the following would normally occur if a firm increases its investment in current assets?
A) The firm's liquidity would be improved.
B) The firm's net working capital would decline.
C) The firm's liquidity would be worsened.
D) The firm's profit margin would improve.
Q:
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?
A) The firm will be relatively more liquid.
B) The firm will be relatively less liquid.
C) The liquidity of the firm will be unchanged.
D) The firm will be more liquid only if interest rates are below the company's weighted average cost of capital.
Q:
In general, the greater a firm's reliance upon short-term debt or current liabilities,
A) the lower will be its liquidity.
B) the greater will be its liquidity.
C) liquidity will remain constant.
D) there will be no effect on liquidity.
Q:
Which of the following actions would decrease a firm's liquidity?
A) selling stock and reducing accounts payable
B) selling machinery and using proceeds to retire bonds
C) reducing accounts receivable and buying bonds
D) selling bonds and holding proceeds in the cash account
Q:
Which of the following actions would improve a firm's liquidity?
A) purchasing inventories for cash
B) purchasing inventory on trade credit
C) purchasing inventory with long-term debt
D) buying machinery with long-term debt
Q:
Which of the following actions would improve a firm's liquidity?
A) repurchasing stock
B) selling bonds and increasing cash
C) buying bonds
D) increasing the company's dividend payments
Q:
Which of the following is an advantage of the use of current liabilities to finance assets?
A) less risk of illiquidity
B) more flexibility
C) lower interest costs
D) both B and C
Q:
Which of the following is a disadvantage of the use of current liabilities to finance assets?
A) greater risk of illiquidity
B) less flexibility
C) higher interest costs
D) the hedging principle
Q:
Which of the following is NOT true regarding the use of short-term debt?
A) It must be rolled over more often than long-term debt.
B) There is uncertainty connected with interest costs on short-term debt from year to year.
C) The firm is subjected to greater liquidity risk when using short-term credit.
D) Interest rates are usually higher on short-term debt.
Q:
All of the following are potential disadvantages of short-term debt EXCEPT
A) short-term debt must be paid back more quickly than long-term debt.
B) uncertainty of interest costs because short-term debt must be replaced often.
C) a greater risk of illiquidity than long-term debt.
D) short-term debt generally has a higher interest cost than long-term debt.
Q:
Interest costs for short-term debt are generally lower than interest costs for long-term debt because
A) the term structure of interest rates generally reflects an upward sloping yield curve.
B) short-term debt is more flexible, allowing a match of short-term needs with short-term financing.
C) investors demand higher returns on short-term debt due to liquidity concerns.
D) both A and B.
Q:
Which of the following statements concerning liquidity and debt is true?
A) The greater the use of short-term debt, the lower the risk of illiquidity.
B) Long-term debt is generally less costly than short-term debt.
C) A firm can reduce its risk for illiquidity by shifting from short-term debt to long-term debt.
D) The risk of illiquidity does not depend on the mix of short-term versus long-term debt.
Q:
A company that increases its liquidity by holding more cash and marketable securities is
A) likely to achieve a higher return on equity because of higher interest income.
B) 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.
C) going to maximize firm value because risk is decreased.
D) going to have to sell common stock to raise the cash to become more liquid.
Q:
Current assets would usually NOT include
A) plant and equipment.
B) marketable securities.
C) accounts receivable.
D) inventories.
Q:
Although interest rates are generally higher on long-term debt, using more long-term debt rather than short-term debt can reduce the risk of illiquidity and decrease uncertainty related to interest rate changes.
Q:
In general, interest rates on short-term debt are higher than interest rates on long-term debt because the borrower has less time to repay the loans, and hence the risk to the lender is higher.
Q:
The risk of illiquidity is increased if either cash and marketable securities are decreased, or if the firm relies more heavily on long-term debt.
Q:
The trade-off associated with holding large amounts of cash and marketable securities is increased liquidity offset by a reduction in the overall rate of return.
Q:
Three basic factors that determine which sources of short-term financing a firm uses are the effective cost of financing, the availability of credit, and the influence of the use of a particular credit source on the cost and availability of other sources of financing.
Q:
Working capital management involves managing a firm's liquidity.
Q:
Achieving a lower inventory balance through working capital management can result in savings from both carrying costs and losses associated with obsolete inventory.
Q:
A company decreases the risk of insolvency by financing long-term assets with short-term debt.
Q:
A firm increases the risks of insolvency by keeping relatively large amounts of money tied up in marketable securities.
Q:
Working capital refers to investment in current assets, while net working capital is the difference between current assets and current liabilities.
Q:
Short-term debt has a greater risk of illiquidity than long-term debt because it must be rolled over more frequently and its use creates more uncertainty concerning future interest rates.
Q:
Short-term debt provides a more flexible form of financing than long-term debt.
Q:
Long-term debt is generally less costly than short-term debt, but also results in more illiquidityhence, the risk-return trade-off.
Q:
Higher liquidity (holding larger cash and marketable securities balances) generally results in a lower return on equity.
Q:
Two advantages of financing with current liabilities are flexibility and lower interest cost.
Q:
Management of a firm's liquidity involves management of the firm's investment in current assets as well as its mix of long-term capital.
Q:
List and describe at least three advantages accrue to the user of commercial paper.
Q:
What is the difference between a line of credit and a revolving credit agreement?
Q:
What are some examples of unsecured and secured sources of short-term credit?
Q:
AJAX Corp. needs $100,000 for the next 30 days. The company has $100,000 in cash it was expecting to use to pay off accounts payable in order to take advantage of the 2/10 net 40 credit terms. Another source of financing is a short-term bank loan with an interest rate of 20%. Would you recommend AJAX borrow the $100,000 it needs from the bank and use the cash it already has to pay its accounts payable and take the cash discount, or would you recommend the company forgo the cash discount and use the $100,000 it has for its financing needs?
Q:
Symco Corp. needs $500,000 for 90 days to get through a period of unexpectedly high oil prices. Symco's line of credit with the bank allows the company to borrow at 6% per year with a compensating balance of 10% of the amount borrowed. Currently, Symco has no money on deposit with the bank.
a. Calculate the amount Symco must borrow to meets its needs plus the compensating balance.
b. What is the annual percentage rate for this financing?
c. If the bank requires discount interest, what is the annual percentage rate for this financing?
Q:
Discuss the similarities and differences between a line of credit and a revolving credit agreement.
Q:
Bonneau Sunglass Co. is considering the factoring of its receivables. The firm has credit sales of $500,000 per month and has an average receivables balance of $1,000,000 with 60-day credit terms. The factor has offered to extend credit equal to 85% of the receivables factored less interest on the loan at a rate of 2% per month. The 15% difference in the advance and face value of all receivables factored consists of a 2% factoring fee plus a 13% reserve, which the factor maintains. In addition, if Bonneau decides to factor its receivables, it will sell them all, so that it can reduce its credit costs by $2,000 a month.
a. What is the cost of borrowing the maximum amount of credit available to Bonneau through the factoring agreement?
b. What considerations other than cost should be accounted for by Bonneau in determining whether or not to enter the factoring agreement?
Q:
Richenstein Enterprises is in the business of selling dishwashers. The firm needs $192,000 to finance an anticipated expansion in receivables due to increased sales. Richenstein's credit terms are net 40, and its average monthly credit sales are $180,000. In general, the firm's customers pay within the credit period; thus, the firm's average accounts receivable balance is $240,000.
The comptroller of Richenstein Enterprises, Mr. Gee, approached their bank for the needed capital, pledging the accounts receivable as collateral. The bank offered to make the loan at a rate of 2 percent over prime plus a 1 percent processing charge on all receivables pledged. The bank agreed to loan up to 80 percent of the face value of the receivables pledged.
a. Estimate the cost of the receivables loan to Richenstein where the firm borrows the $192,000. The prime rate is currently 13%.
b. Gee also requested a line of credit for $192,000 from the bank. The bank agreed to grant the necessary line of credit at a rate of 4% over prime and required a 12% compensating balance Gee currently maintains an average demand deposit of $40,000. Estimate the cost of the line of credit to Richenstein.
c. Which source of credit should Richenstein Enterprises select?
Q:
Quincy Fathows & Co. plans to issue commercial paper for the first time in its 85-year history. The firm plans to issue $400,000 in 120-day maturity notes. The paper will carry a 13% quarterly compounded rate with discounted interest and will cost Quincy Fathows $8,000 in advance to issue.
a. What is the effective cost of credit to Quincy Fathows?
b. What other factors should the firm consider in analyzing whether or not to issue the commercial paper?
Q:
Dazzly Diamond Corp. called for credit at the Home Alone Bank of Paris, TX. The terms included a $35,000 maximum loan with interest of 1 percent over prime, and the agreement also requires a 15% compensating balance throughout the year. The prime rate is currently 12 percent.
a. If Dazzly Diamond Corp. maintains a balance in its account of $5,250 to $6,000, what is the effective cost of credit through the line-of-credit agreement where the maximum amount of the loan is used?
b. Recompute the effective cost of credit to Dazzly Diamond if it will have to borrow the compensating balance and the maximum amount possible under the agreement.
Q:
Crenshaw Inc. has a $400,000 line of credit with a local bank. The bank requires a compensating balance of 10% of the loan and extends credit to Crenshaw at 1% over the current prime rate. Crenshaw needs the use of $200,000 for the three-month period. They currently have no deposits with the lending bank.
a. What will the effective annual cost of this credit be? (Assume a 360-day year and a 9% prime rate.)
b. Using the above information, what would be the effective interest rate if the firm discounted the interest on the loan?
Q:
Your company needs to pay $10,000 for the overhaul of five trucks. A bank offers you a loan at 18 percent per annum with a compensating balance requirement of 15 percent of the loan amount. You plan to borrow the money for 9 months and currently do not have any account with this bank. What is the effective cost of the loan?
Q:
AAC, Inc. is planning to issue $5,000,000 in 180-day maturity notes paying a rate of 12 percent per annum. The company expects to incur costs of approximately $20,000 in dealer placement fees and other expenses of issuing the commercial paper. The company plans to back up their commercial paper offering with a line of credit from a bank for $5,000,000. The compensating balance requirement is 10 percent of the line of credit. The company normally maintains $450,000 in its accounts with the bank. What is the effective cost of the commercial paper offering?
Q:
The effective interest rate on short-term loans from Bank A is 12.5 percent per year. Bank B claims that their interest rate is only 11 percent per year. However, Bank B charges interest on a discount basis. Which bank is charging the lowest effective rate of interest on a one-year loan?
Q:
MovieTone, Inc. is a producer and distributor of specialty DVDs. It sells directly to large retail firms on terms of net 60 and has average monthly sales of $350,000. It has recently decided to pledge all of its accounts receivable to its bank. The bank advances up to 80 percent of the face value of these receivables at a rate of 4 percent over the prime rate, while charging 2.5 percent on all receivables pledged for processing to cover billing and collection services. Prior to this arrangement MovieTone was spending $50,000 a year on its credit department. The prime rate is 6 percent.
a. What is the average level of accounts receivable?
b. What is the effective cost of using this short-term credit for one year?
Q:
The Smith Corporation is a maker of fine stereo components and presently has finished goods inventories of $800,000. They need a short-term bank loan of $400,000 for three months. The bank has proposed two different financing arrangements. The first is a floating lien arrangement at a rate of 22 percent. The second proposal is for a terminal warehouse arrangement at 11 percent. Under the latter proposal, Smith will pay $1,000 a month plus round trip shipping expense of $6,000. Which source of credit should be selected by the Smith Corporation? Explain.
Q:
Worthington, Inc. is planning to issue $7,500,000 in 120-day maturity notes carrying a rate of 11 percent per year. Worthington's commercial paper will be placed at a cost of $35,000. What is the effective cost of credit to Worthington?
Q:
The Rosewood Corporation established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $500,000 at a rate of 10 percent. A compensating balance averaging 15 percent of the loan is required. Prior to the agreement, Rosewood had maintained an account at the bank averaging $25,000. Any additional funds needed for the compensating balance will also have to be borrowed at the 10 percent rate. If the firm needs $280,000 for 6 months, what is the annual cost of the loan?
Q:
Calculate the effective cost of the following trade credit terms if the discount is forgone and payment is made on the net due date.
a. 2/10 net 50
b. 2/15 net 60
c. 2/20 net 45
Q:
All of the following are true EXCEPT
A) Trade credit represents inventories sold to customers.
B) Temporary investments are current assets that will be liquidated and not replaced within the current year.
C) Permanent investments are assets a firm expects to hold for longer than one year.
D) Compensating balance requirements increase the cost of financing.
Q:
Which of the following statements about factoring is true?
A) The firm, not the factor, bears the risk of collecting bad receivables in a factoring arrangement.
B) Factoring involves the outright sale of a firm's accounts receivable to the factor.
C) The borrowing firm is able to obtain a greater advance against inventory in a factoring arrangement than in a typical line of credit secured by accounts receivable.
D) Factoring firms sell the receivables of other firms.
Q:
Nike Corp. buys on 3/10, net 30 days. What is the nominal cost of interest if Nike does not take advantage of the trade discount offered? Assume a 360-day year.
A) 12.0%
B) 22.3%
C) 55.7%
D) 66.3%
Q:
What is the primary advantage of a firm that is able to issue commercial paper to finance its short-term assets?
A) Commercial paper provides greater flexibility in terms of repayment.
B) Interest rates on commercial paper are generally lower than rates on bank loans.
C) Commercial paper does not need to be repaid.
D) Commercial paper is guaranteed by the Federal Government
Q:
The terminal warehouse agreement differs from the field warehouse agreement in that
A) the cost of the terminal warehouse agreement is lower due to the lower degree of risk.
B) the borrower of the field warehouse agreement can sell the collateral without the consent of the lender.
C) the warehouse procedure differs for both agreements.
D) the terminal agreement transports the collateral to a public warehouse.
Q:
The primary advantage that pledging accounts receivable provides is
A) the flexibility it gives to the borrower.
B) that the financial institution bears the risk of collection.
C) the low cost as compared with other sources of short-term financing.
D) that the financial institution services the accounts.
Q:
A floating lien, chattel mortgage, or terminal warehouse receipt have which of the following in common?
A) They all pledge accounts receivables as security.
B) They have nothing in common.
C) They are all unsecured forms of financing.
D) They all use inventory to secure a loan.
Q:
The effective annual cost of not taking advantage of the 1/10, net 60 terms offered by a supplier is
A) 1.50%.
B) 5.37%.
C) 6.69%.
D) 7.27%.
Q:
The Native Industries, Inc. 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 Native Industries?
A) 13.46%
B) 14.06%
C) 14.45%
D) 15.38%
Q:
The Missouri River Pendant 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 Missouri River?
A) 7.7%
B) 7.5%
C) 7.3%
D) 7.1%
Q:
Which of the following is an unsecured short-term bank loan made for a specific purpose?
A) mortgage bond
B) line of credit
C) revolving credit agreement
D) transaction loan
Q:
DAS, Inc. has a line of credit with FBT Bank that allows DAS to borrow up to $400,000 at an annual interest rate of 11 percent. However, DAS must keep a compensating balance of 25 percent of any amount borrowed on deposit at the bank. DAS does not normally have a cash balance account with the bank. What is the effective annual cost of credit?
A) 11.45%
B) 12.59%
C) 14.67%
D) 16.00%
Q:
Crawley, Inc. has a line of credit with HNC Bank that allows the company to borrow up to $800,000 at an interest rate of 12 percent. However, Crawley, Inc. must keep a compensating balance of 18 percent of any amount borrowed on deposit at the bank. Crawley, Inc. does not normally keep a cash balance account with HNC Bank. What is the effective annual cost of credit?
A) 12.40%
B) 12.83%
C) 14.63%
D) 15.47%
Q:
The Boyles Ceramics, Inc. 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, Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay off a note that was due. Boyles 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?
A) 11.94%
B) 11.00%
C) 10.83%
D) 10.57%
Q:
The Boyles Ceramics, Inc. 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, Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay off a note that was due. Boyles decides to borrow an amount sufficient to pay the $240,000 note and also to cover the compensating balance. How much must Boyles Glass borrow?
A) $300,000
B) $320,000
C) $375,000
D) $400,000
Q:
The Boyles Ceramics, Inc. 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, Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles 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?
A) 12.50%
B) 11.11%
C) 10.67%
D) 8.85%