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Chapter 19

Cash and Marketable Securities Management

True/False

1. Near-cash assets consist of accounts receivable and inventory.

Difficulty: Easy

Keywords: near cash assets

2. In actual business practice, the precautionary motive is met to a large extent by holding a portfolio of fixed assets.

Difficulty: Moderate

Keywords: precautionary motive

3. The largest cash receipts for a firm come from accounts payable.

Difficulty: Easy

Keywords: cash receipts, accounts receivable

4. Because they operate within a highly uncertain environment, utilities hold a large percentage of their total assets in cash.

Difficulty: Moderate

Keywords: cash holdings and business environments

5. Firms like to hold large stocks of cash because it minimizes the risk of becoming insolvent.

Difficulty: Moderate

Keywords: cash holdings

6. The payment of dividends would be considered an irregular basis for cash balance reduction.

Difficulty: Easy

Keywords: cash dividends, irregular basis for cash reduction

7. Concentration banking is a method of moving funds electronically between bank accounts in order to eliminate float.

Difficulty: Easy

Keywords: concentration banking

8. Use of concentration banking centralizes the firm’s stock of cash.

Difficulty: Moderate

Keywords: concentration banking

9. One of the benefits of an automated depository transfer check system is the elimination of mail float.

Difficulty: Moderate

Keywords: mail float

10. The fastest way to move cash between banks is by wire transfer.

Difficulty: Easy

Keywords: wire transfer

11. A zero balance account permits divisions to disburse funds while maintaining centralized control of several bank accounts.

Difficulty: Easy

Keywords: zero balance account

12. Capability of paying through drafts, zero balance accounts, and remote disbursing all help to decrease disbursement float.

Difficulty: Moderate

Keywords: reducing disbursement float

13. An irregular cash outflow is payment of taxes.

Difficulty: Easy

Keywords: irregular cash flow

14. Inventories are purchased on an irregular basis to ensure a steady flow of finished goods off the production line.

Difficulty: Moderate

Keywords: inventory, regular cash flow

15. The funds needed to satisfy the precautionary motive should be entirely held in cash.

Difficulty: Moderate

Keywords: cash holdings

16. Speculative balances are a buffer stock of liquid assets.

Difficulty: Easy

Keywords: precautionary balances

17. The Treasury Department has criticized the practice of remote disbursing.

Difficulty: Moderate

Keywords: remote disbursing

18. A financial manager should be willing to assume greater financial risk in the marketable securities portfolio so long as the expected return is commensurate with the risk.

Difficulty: Moderate

Keywords: financial risk

19. Price volatility is higher for long-term investments than for short-term investments.

Difficulty: Moderate

Keywords: interest rate risk

20. Securities that are traded in thin markets are not likely to be considered liquid.

Difficulty: Moderate

Keywords: liquid securities

21. Municipals tend to sell at a higher yield-to-maturity in the market than securities that pay taxes.

Difficulty: Moderate

Keywords: municipal securities

22. T-bills and Treasury bonds are guaranteed by the full faith and credit of the United States and are therefore default-free.

Difficulty: Easy

Keywords: T-bills and treasury bonds

23. A banker’s acceptance is a draft drawn on a specific bank by an exporter in order to obtain payment for goods that he has shipped to a customer who maintains an account with that specific bank.

Difficulty: Moderate

Keywords: banker’s acceptance

24. Interest rate risk refers to the uncertainty of expected returns from security attributes.

Difficulty: Moderate

Keywords: financial risk

25. A negotiable certificate of deposit (CD) is a marketable receipt for funds deposited in a bank.

Difficulty: Easy

Keywords: negotiable certificate of deposit

26. Although CDs are slightly more risky than Treasury bills, the yield is usually slightly less.

Difficulty: Moderate

Keywords: certificates of deposit

27. Commercial paper is a short-term, unsecured promissory note.

Difficulty: Easy

Keywords: commercial paper

28. One of the attractive features of commercial paper is an active secondary market.

Difficulty: Easy

Keywords: commercial paper

29. The corporation that buys a repurchase agreement is protected against market price fluctuations throughout the contract period.

Difficulty: Moderate

Keywords: repurchase agreements

30. Yields on various financial instruments tend to be positively correlated over time.

Difficulty: Moderate

Keywords: security yields

31. Due to their large denominations, U.S. Treasury bills are the least popular short-term investment among firms.

Difficulty: Moderate

Keywords: T-bills

32. Treasury bills are sold on a discount basis.

Difficulty: Easy

Keywords: Treasury bills, discount pricing

33. The minimum denomination of U.S. Treasury bills is $10,000.

Difficulty: Easy

Keywords: T-bills denomination

34. Six-month U.S. Treasury bills are auctioned every week.

Difficulty: Easy

Keywords: T-bills action process

35. The returns to investors of money market funds will fluctuate with changes in market rates of interest.

Difficulty: Moderate

Keywords: money market funds

36. Cash includes the amount of currency that the firm has in a checking account at a commercial bank.

Difficulty: Moderate

Keywords: cash

37. Marketable securities are near-cash assets because they can be converted into cash quickly.

Difficulty: Moderate

Keywords: marketable securities

38. The industry in which a firm operates has relatively little effect on the relative amounts of transaction cash held.

Difficulty: Moderate

Keywords: industry and cash holdings

39. Firms competing in the same industry can expect to experience similar demands on their cash balances.

Difficulty: Moderate

Keywords: industry and cash holdings

40. Speculative cash balances are held to take advantage of uncertain profit-making opportunities.

Difficulty: Moderate

Keywords: speculative cash balances

41. A Treasury bill is a near-cash asset.

Difficulty: Easy

Keywords: Treasury bill

42. With a preauthorized check system, the customer of the firm no longer writes his or her own check.

Difficulty: Moderate

Keywords: preauthorized check system

43. Zero balance accounts reduce disbursing float.

Difficulty: Easy

Keywords: zero balance accounts

44. The primary purpose of payable-through drafts is to provide effective control over field payments.

Difficulty: Moderate

Keywords: payable-through drafts

45. Payable-through drafts are similar to ordinary checks in that they are both drawn on a bank.

Difficulty: Moderate

Keywords: payable-through drafts

46. Commercial paper can be described as a short-term corporate IOU.

Difficulty: Moderate

Keywords: commercial paper

47. A security is considered liquid if it can be sold, regardless of the time it takes to make the sale.

Difficulty: Moderate

Keywords: liquid security

48. If revenues can be forecast to fall within a tight range of outcomes, then the ratio of cash and near-cash to total assets will be greater for the firm than if the prospective cash inflows might be expected to vary over a wide range.

Difficulty: Moderate

Keywords: ratio of cash and near-cash to total assets

49. The most important reason firms hold cash balances is the transaction motive.

Difficulty: Moderate

Keywords: motives for holding cash

50. Lock box arrangements yield benefits for all companies regardless of the size of sales or customer remittance checks.

Difficulty: Moderate

Keywords: lock box

51. With payable-through drafts, the firm serves as a collection point and passes the drafts on to the bank.

Difficulty: Moderate

Keywords: payable-through drafts

52. Electronic funds transfer (EFT) could eventually eliminate the use of most checks and minimize float.

Difficulty: Moderate

Keywords: electronic funds transfer

53. Marketable securities are only those security investments the firm can convert into cash balances within one year.

Difficulty: Moderate

Keywords: marketable securities

54. Both depository transfer checks and wire transfers are used in conjunction with what is known as concentration banking.

Difficulty: Moderate

Keywords: concentration banking

55. Zero balance accounts permit numerous divisional dispersing accounts all located at the same concentration bank.

Difficulty: Moderate

Keywords: zero balance accounts

56. Municipal obligations, or municipals, are not tax-exempt at the federal level.

Difficulty: Moderate

Keywords: municipals

57. One factor that determines the amount of cash needed to satisfy a firm’s transactions requirements is the firm’s industry.

Difficulty: Moderate

Keywords: cash requirement and industry

58. The speculative motive for holding cash relates to the maintenance of balances to be used to satisfy possible, but as yet indefinite, needs.

Difficulty: Moderate

Keywords: motives for holding cash

59. The precautionary motive for holding cash is met to a large extent by the holding of a portfolio of liquid assets, not just cash.

Difficulty: Moderate

Keywords: motives for holding cash

60. The precautionary motive for holding cash addresses the firm’s desire to take advantage of potential profit-making situations.

Difficulty: Moderate

Keywords: motives for holding cash

61. Precautionary balances are a buffer stock of liquid assets.

Difficulty: Moderate

Keywords: precautionary balances

62. The precautionary motive is the primary reason why a company holds cash balances.

Difficulty: Moderate

Keywords: motives for holding cash

63. Generally, the speculative motive is the least important component of a firm’s preference for liquidity.

Difficulty: Moderate

Keywords: motives for holding cash

64. Many manufacturing firms generate cash on a regular basis through the liquidation of scrap or obsolete inventory.

Difficulty: Moderate

Keywords: sources of cash, internal operations

65. Large cash investments minimize the chance of insolvency and enhance the firm’s profitability.

Difficulty: Moderate

Keywords: insolvency

66. Typically, funds available in the firm’s bank accounts exceed the balances indicated on the firm’s books.

Difficulty: Moderate

Keywords: cash balances

67. The lock box system is the most widely used commercial banking service for expediting cash gathering.

Difficulty: Moderate

Keywords: lock box system

68. The lock box system speeds up the conversion of receipts into usable funds by reducing both mail and disbursing float.

Difficulty: Moderate

Keywords: lock box system

69. A preauthorized check does not contain or require the signature of the person on whose account it is being drawn.

Difficulty: Moderate

Keywords: preauthorized checks

70. Mail float and processing float can be dramatically reduced when using a preauthorized check system in comparison with other payment processing systems.

Difficulty: Moderate

Keywords: mail float, processing float

71. Transit float is caused by the time required for the firm to process remittance checks before they can be deposited in the bank.

Difficulty: Moderate

Keywords: transit float

72. The automated depository transfer check system eliminates mail float.

Difficulty: Moderate

Keywords: mail float

73. The Federal Reserve Wire System is directly accessible to commercial banks that are members of the Federal Reserve System.

Difficulty: Moderate

Keywords: Federal Reserve Wire System

74. Remote disbursing aims solely to reduce disbursement float.

Difficulty: Moderate

Keywords: remote disbursement float

75. Payable-through drafts have the physical appearance of ordinary checks and are drawn on a bank.

Difficulty: Moderate

Keywords: payable-through drafts

76. Instantaneous electronic funds transfer would eliminate all types of float.

Difficulty: Moderate

Keywords: electronic funds transfer

77. To hedge against the price volatility caused by interest rate risk, the firm’s marketable securities portfolio will tend to be composed of instruments that mature over short periods.

Difficulty: Moderate

Keywords: interest rate risk

78. A firm will avoid investing in marketable securities with thin markets if the firm is concerned about the liquidity of its marketable securities portfolio.

Difficulty: Moderate

Keywords: liquidity

Multiple Choice

79. Which of the following would increase cash flow for a firm?

a. Purchase of marketable securities

b. Purchase of fixed assets

c. Credit sales

d. Cash sales

Difficulty: Easy

Keywords: cash inflows

80. John Maynard Keynes segmented a firm’s demand for cash into the ____________ motives.

a. risk, investment, and liquidity

b. transaction, speculative, and precautionary

c. transaction, liquidity, and speculative

d. transaction, speculative, and risky

Difficulty: Moderate

Keywords: motives for cash

81. A construction firm that accumulates cash in anticipation of a significant drop in lumber costs is an example of the __________ motive for holding cash.

a. transaction

b. speculative

c. hedging

d. building

Difficulty: Moderate

Keywords: motives for cash

82. One would expect to find a relatively low level of liquid assets in which industry?

a. Retail trade

b. Services

c. Utilities

d. Construction

Difficulty: Easy

Keywords: industry and cash holdings

83. A company is technically insolvent when:

a. cash outflows in a given period are greater than cash inflows.

b. earnings before interest payments are less than the interest payments.

c. it lacks the necessary liquidity to promptly pay its current debt obligations.

d. the current ratio is less than 1.0.

Difficulty: Moderate

Keywords: insolvency

84. Transit float is caused by the time:

a. necessary for a deposited check to clear the banking system and become usable funds to the company.

b. funds are not available, through the company’s bank account, until its payment check has cleared the banking system.

c. from the moment a customer mails his remittance check until the firm begins to process it.

d. required for the firm to process remittance checks.

Difficulty: Moderate

Keywords: transit float

85. Assume that liquid funds can be invested to yield 12%. If annual remittance checks total $2 billion, what is it worth for the firm to reduce float by one day?

a. $658,000

b. $542,000

c. $431,000

d. $354,000

Difficulty: Moderate

Keywords: reducing float

86. The benefits of a lock box arrangement include:

a. elimination of clerical functions.

b. early knowledge of dishonored checks.

c. decreased working cash.

1. both a and b.
2. all of the above.

Difficulty: Moderate

Keywords: lock box system

87. Preauthorized check systems reduce:

a. postage costs.

b. cash flows.

c. processing float.

1. both a and c.
2. all of the above.

Difficulty: Moderate

Keywords: preauthorized check system, advantages

88. Concentration banks:

a. receive surplus balances from multiple bank accounts in different geographic areas of the country.

b. transfer excess cash via a CD.

c. eliminate mail float entirely by using preauthorized checks to transfer funds.

d. disburse payables from remote locations.

Difficulty: Easy

Keywords: concentration banking

89. Improvements in the management of disbursements include:

a. field payment control.

b. automated depository transfer checks.

c. zero balance accounts.

d. disbursed float.

Difficulty: Moderate

Keywords: zero balance accounts

90. The preauthorized check system is used often by:

a. automobile dealers.

b. insurance companies.

c. jewelers.

d. appliance stores.

Difficulty: Moderate

Keywords: preauthorized checks

91. Payable-through drafts:

a. provide for effective control over field payments.

b. are legal instruments.

c. cannot be cleared through the banking system.

1. both a and b.
2. all of the above.

Difficulty: Moderate

Keywords: payable-through drafts

92. Which of the following is true about lock box systems?

a. Reduces transit float

b. Most widely used system for expediting cash

c. Increases mail float

1. Both a and c
2. All of the above

Difficulty: Moderate

Keywords: lock box system

93. _______ provide the means for moving funds from local bank accounts to concentration accounts.

a. Payable-through drafts

b. Depository transfer checks

c. Wire transfers

d. Bank wires

Difficulty: Moderate

Keywords: depository transfer checks

94. The financial manager should include the following security in a portfolio of marketable securities.

a. High-grade shares of common stock

b. Long-term shares of common stock

c. High-quality preferred stock

d. High-grade commercial paper

Difficulty: Moderate

Keywords: portfolio of marketable securities

95. Given that short-term interest rates typically fluctuate more than long-term rates, interest rate risk is least for:

a. Treasury bills.

b. common stock.

c. long-term government bonds.

d. medium-term corporate bonds.

Difficulty: Moderate

Keywords: Treasury bills, interest rate risk

96. An investor in the 40% tax bracket owning a tax-exempt bond yielding 6% realizes an equivalent before-tax yield of:

a. 12%.

b. 10%.

c. 8%.

d. 6%.

Difficulty: Moderate

Keywords: before-tax yield

97. Federal agency securities:

a. are guaranteed by the U.S. Government.

b. include stock of the Federal Reserve Board.

c. all have a denomination or face value of $10,000.

d. have a yield greater than Treasury securities of identical maturity.

Difficulty: Moderate

Keywords: federal agency securities

98. Money market funds:

a. are one of the oldest forms of mutual funds.

b. typically invest in a diversified portfolio of short-term, high-grade debt instruments.

c. are generally very profitable but fail to provide liquidity to the small investor.

d. typically sell shares to the public in $5,000 denominations.

Difficulty: Moderate

Keywords: money market funds

99. Which of the following is NOT a motive for holding cash as identified by John Maynard Keynes?

a. The transactions motive

b. The economic motive

c. The speculative motive

d. Risk aversion

Difficulty: Moderate

Keywords: motives for holding cash

100. The Smat Grape Company generally has a reasonably high demand for cash to pay migrant workers during harvest (July and August). During the rest of the year, Smat generally keeps a cash balance of $20,000; however, during harvest the daily cash balance is kept at a minimum of $75,000. According to Keynes, which of the following motives best describes Smat’s motive for maintaining the additional $55,000 during the harvest season?

a. Precautionary

b. Speculative

c. Profit

d. Transaction

Difficulty: Moderate

Keywords: motives for holding cash

101. The precautionary motive for holding cash assumes that balances are held:

a. to satisfy the need for cash that arises in the ordinary course of doing business.

b. to satisfy possible but as yet indefinite needs.

c. as a precaution against missing possible profit-making opportunities.

d. for speculative purposes.

Difficulty: Moderate

Keywords: motives for holding cash

102. Of the following motives, which is the least important for holding cash according to John Maynard Keynes?

a. Transaction

b. Economic

c. Profit

d. Speculative

Difficulty: Moderate

Keywords: motives for holding cash

103. The primary concern in the management of cash and marketable securities for an operating company is to:

a. be profitable.

b. balance liquidity needs against investment opportunities.

c. keep enough cash on hand to buy a competitor if it becomes available.

1. both a and c.
2. all of the above.

Difficulty: Moderate

Keywords: management of cash and marketable securities, liquidity

104. Which of the following statements is the least consistent with modern cash management theory?

a. If a company keeps too much cash on hand, a corporate raider could use the excess cash as part of the financing of a hostile take-over.

b. Keeping more cash than is needed increases the company’s ability to weather a short-term recession.

c. The more cash a company keeps, the less creative its management appears to stock market analysts.

d. The more cash a company keeps, the better off it is at all times.

Difficulty: Moderate

Keywords: modern cash management theory

105. Why are domestic cash management systems less complicated than international cash management systems?

a. Domestic systems do not have to allow for currency fluctuations.

b. International cash management systems are not affected by interest rate differences.

c. International cash management systems actually are less complicated because the rest of the world’s major countries are more attuned to the advantages of electronic funds transfer.

d. International cash management systems actually are less complicated because transactions are fewer but for larger sums of money.

Difficulty: Moderate

Keywords: cash management systems

106. What type of float can be reduced with a lock box arrangement?

a. Mail

b. Processing

c. Transit

d. All of the above

Difficulty: Easy

Keywords: lock box systems, float

107. __________ permit centralized control over cash outflows while maintaining divisional disbursing authority.

a. Zero balance accounts

b. Electronic funds transfers

c. Payable-through drafts

d. Lock box systems

Difficulty: Moderate

Keywords: zero balance accounts

108. Preauthorized checks can reduce which of the following types of float?

a. Mail

b. Processing

c. Transit

d. Both a and b

e. All of the above

Difficulty: Moderate

Keywords: preauthorized checks

109. Which of the following can be used by a company to increase its disbursing float?

a. Remote disbursing

b. Wire transfer

c. Depository transfer checks

d. Payable-through draft

Difficulty: Moderate

Keywords: disbursing float

110. Which of the following can be used to decrease a firm’s processing float?

a. Lock box arrangement

b. Preauthorized checks

c. Wire transfer

d. Zero balance account

Difficulty: Moderate

Keywords: processing float

111. Transit float can be reduced through the use of:

a. a lock box system.

b. preauthorized checks.

c. wire transfers.

d. both a and c.

e. all of the above.

Difficulty: Moderate

Keywords: transit float

112. __________ float is caused by the time necessary for a deposited check to clear through the commercial banking system.

a. Processing

b. Transit

c. Mail

d. Disbursing

Difficulty: Moderate

Keywords: transit float

113. A Dallas company is considering the use of a remote disbursing scheme to increase the disbursing float to its dividend checks. The company has determined that by writing checks on a Ridgeway, Pennsylvania bank, the disbursing float can be increased by an average of four days. The dividend to be issued on November 1 is $.10 per share, and the company has 10 million outstanding shares. How much will the company make by using the scheme for dividend payments? Assume that the company invests idle cash in a money market fund paying 9% interest.

a. $1,000

b. $2,000

c. $3,000

d. $4,000

Difficulty: Moderate

Keywords: remote disbursing

114. The Stone Duck Manufacturing Company is considering the use of a lock box collection system. Stone Duck’s average check receipt is $150. The company invests excess cash in money market certificates and receives an average of 8% annual interest. The lock box system will speed up Stone Duck’s collections by 2.5 days. What is the maximum per-check processing cost that Stone Duck should be willing to pay for the lock box system (round to the nearest $.001)?

a. $.083

b. $.094

c. $.101

d. $.117

Difficulty: Moderate

Keywords: lock box systems

115. The Decorative Imitation Flamingo Manufacturing Company (DIFCO) processes an estimated 50,000 checks per year from its customers. Total revenues collected by check are $10 million. The average float time until the funds are credited to DIFCO’s checking account is eight days. For an extra cost of $.09 per check, DIFCO’s bank will install a lock box system that will reduce float time from eight days to five days. If DIFCO earns 8% on its checking account, how much per check will DIFCO make if it uses the lock box system (round to the nearest $.001)?

a. $.058

b. $.052

c. $.047

d. $.043

Difficulty: Moderate

Keywords: lock box systems

116. The Stonely Manufacturing Company will collect an estimated $4 million next year, and it will receive an estimated 10,000 checks. Stonely’s bank has offered to set up a lock box system that will reduce float time by 2.5 days. The cost of the system will be $.22 per check. What is the minimum annual interest rate on its cash balance that Stonely should receive before it would be willing to adopt the lock box system (round to the nearest 1%)?

a. 7%

b. 8%

c. 9%

d. 10%

Difficulty: Moderate

Keywords: lock box systems

117. Compare the risk of a 90-day unsecured promissory note issued by Southwest Airlines to a 20-year U.S. Government Treasury bond. The Treasury bond will have:

a. lower financial risk.

b. higher interest rate risk.

c. default risk.

d. both a and b.

Difficulty: Moderate

Keywords: Treasury securities and risk

118. Which of the following is not a primary factor that should be considered in the selection of a marketable security?

a. The safety of the instrument

b. The maturity of the instrument

c. Whether it is sold at a discount or it bears interest

d. The expected yield

Difficulty: Moderate

Keywords: marketable securities

119. Which of the following has the least interest rate risk?

a. A six-month unsecured promissory note from International Harvester

b. An eight-year investment certificate from a federally insured bank

c. A 15-year U.S. Treasury bond

d. An AT&T bond maturing in 2010

Difficulty: Moderate

Keywords: interest rate risk

120. Which of the following securities have federal tax-exempt interest payments?

a. Treasury bills

b. Municipal bonds

c. Commercial paper

1. Both a and b
2. All of the above

Difficulty: Moderate

Keywords: municipals

121. If you compare the yield of a municipal bond with that of a Treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 6% per year for an investor in the 36% tax bracket (round to nearest .1%)?

a. 9.4%

b. 8.1%

c. 7.7%

d. 6.3%

Difficulty: Moderate

Keywords: equivalent before-tax yield

122. If you compare the yield of a municipal bond with that of a Treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 7% per year for an investor in the 31% tax bracket (round to nearest .1%)?

a. 8.9%

b. 9.7%

c. 10.1%

d. 11.6%

Difficulty: Moderate

Keywords: equivalent before-tax yield

123. If you compare the yield of a municipal bond with that of a Treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 5% per year for 10 years (round to the nearest whole percentage)? Assume that the investor is in the 31% tax bracket.

a. 5%

b. 6%

c. 7%

d. 8%

Difficulty: Moderate

Keywords: equivalent before-tax yield

124. If you compare the yield of a municipal bond with that of a Treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 5% per year for an investor in the 44% tax bracket (round to the nearest .1%)?

a. 6.6%

b. 7.1%

c. 8.9%

d. 9.4%

Difficulty: Moderate

Keywords: equivalent before-tax yield

125. Which of the following marketable securities is sold on a discount basis?

a. A Treasury bill

b. A Treasury note

c. Bankers Acceptances

d. A CD

Difficulty: Moderate

Keywords: Treasury bill

126. Which of the following types of marketable securities represents an unsecured short-term promissory note issued by a corporation?

a. A money market fund

b. Negotiable orders of withdrawal [NOW]

c. CDs

d. Commercial paper

Difficulty: Moderate

Keywords: commercial paper

127. A money market deposit account [MMDA] has a:

a. higher expected return than a long-term government bond account.

b. tax-free status.

c. limited number of deposits or withdrawals per month.

1. both a and c.
2. all of the above.

Difficulty: Moderate

Keywords: money market deposit account

128. An investor in the 23% tax bracket is considering the following three investments. All three bonds mature in 10 years. Which bond has the highest before-tax yield?

a. City of Denver, municipal bond 6%

b. Federal Home Loan Bank bond 7.6%

c. U.S. Treasury bond 8%

d. City of Sacramento, municipal bond 10%

Difficulty: Moderate

Keywords: before-tax yield

129. Which of the following generally have maturities of one year or less?

a. Treasury bills

b. Money market mutual fund

c. Commercial paper

d. Both a and c

e. All of the above

Difficulty: Easy

Keywords: short-term securities

130. Which of the following are short-term, unsecured promissory notes sold by large businesses?

a. Negotiable CD

b. Repurchase agreements

c. Money market mutual funds

d. Commercial paper

Difficulty: Easy

Keywords: commercial paper

131. Which of the following are characteristics of repurchase agreements?

i. Agreements are written for very short periods of time.

ii. Agreements are generally written for six months or more.

iii. U.S. Government issues are often sold and then repurchased.

iv. The agreements are usually executed in sizes of $500,000 or less.

a. i

b. ii and iii

c. ii, iii, and iv

d. i and iii

Difficulty: Moderate

Keywords: repurchase agreements

132. Which of the following is the least liquid?

a. U.S. Treasury bills

b. Treasury bonds

c. Money market mutual funds

d. Real estate investment trust (REIT)

Difficulty: Easy

Keywords: liquidity and securities

133. Which of the following affects the precautionary motive for holding cash?

a. Cash flow predictability

b. Relative level of inflation

c. Amount of equity a firm has outstanding

d. Level of interest rates

Difficulty: Moderate

Keywords: motives for holding cash

134. The financial manager is concerned with:

a. striking a balance between holding too much cash and holding too little cash.

b. maintaining high levels of profitability.

c. minimizing the chance of insolvency.

d. all of the above.

Difficulty: Easy

Keywords: financial manager and cash management

135. The annual value of one day of float reduction is:

a. (sales per day) × (assumed yield)

b. (sales per year) × (assumed yield) × (days’ float reduction)

c. (sales per unit) × (assumed yield)

d. (sales per unit) ÷ number of days per year

Difficulty: Moderate

Keywords: float

136. A managerial benefit of a lock box arrangement is:

a. better audit control of the documents received.

b. elimination of clerical functions.

1. less chance of losing documents.

d. all of the above.

Difficulty: Easy

Keywords: lock box systems

137. Payable-through drafts:

a. are drawn on a bank.

b. maintain control over field-authorized payments.

c. are used extensively in the insurance industry.

1. both b and c.
2. all of the above.

Difficulty: Moderate

Keywords: payable-through drafts

138. A company that has an unpredictable cash flow and is holding cash because of things that might happen due to this uncertainty is holding a larger minimum cash balance due to which type of motive?

a. Transaction

b. Precautionary

c. Speculative

d. Common sense

Difficulty: Moderate

Keywords: motives for holding cash

139. Of the following companies, which would you expect to have the lowest liquid assets to total asset ratio?

a. Atlas Power and Light (a public utility)

b. Al’s Airways (an air passenger carrier)

c. Steve’s Motorcoach (a major automobile manufacturer)

Difficulty: Moderate

Keywords: industry and liquidity

140. Firm X has assets whose book value exceeds the firm’s total liabilities, but Firm X lacks the liquidity to pay its current debt obligations. Firm X can be said to be:

a. bankrupt.

b. technically insolvent.

c. in economic failure.

d. in a bind.

Difficulty: Moderate

Keywords: insolvency

141. _______ is caused by the time necessary for a deposited check from a customer to clear through the commercial banking system and become usable funds to the company.

a. Mail float

b. Processing float

c. Transit float

d. Disbursing float

Difficulty: Moderate

Keywords: transit float

142. Bill’s Fly-By-Night, Inc. recently wrote a check to Doug’s Fraud Insurance, Inc. The funds will remain in Bill’s bank account until its payment check clears. This refers to:

a. mail float.

b. processing float.

c. transit float.

d. disbursing float.

Difficulty: Moderate

Keywords: disbursing float

143. The objective of a preauthorized check system is to reduce:

a. mail float.

b. processing float.

1. disbursing float.
2. both a and b.

e. all of the above.

Difficulty: Moderate

Keywords: preauthorized checks

144. A way of managing a firm’s cash disbursements would be through:

a. zero balance accounts.

b. payable-through drafts.

c. remote disbursing.

d. all of the above.

Difficulty: Easy

Keywords: managing cash disbursements

145. Firms use remote disbursements to:

a. decrease mail float.

b. increase disbursing float.

c. decrease disbursing float.

d. increase processing float.

Difficulty: Moderate

Keywords: remote disbursements

146. Which of the following does not have an important direct effect on cash flow?

a. The payment patterns of customers

b. The time it takes for suppliers to process payments made by check

c. The ability of the banking system to process checks efficiently

d. The general direction of the Federal Reserve Board’s interest rate policy

Difficulty: Moderate

Keywords: cash impacts

147. Cash held in order to take advantage of potential profit-making situations is referred to as the _______ motive for holding cash.

a. speculative

b. transaction

c. liquidity

d. precautionary

Difficulty: Easy

Keywords: motives for holding cash, speculative motive

148. The four elements of float include:

a. mail, processing, transit, and bank wires.

b. mail, processing, transit, and disbursing.

c. mail, transit, disbursing, and remittance.

d. mail, processing, transaction, and disbursing.

Difficulty: Moderate

Keywords: categories of float

149. ZZZ Corp. ended the day with a cleared balance in its bank account of $7,000. The company deposited $50,000 in checks received from customers the next day. It wrote checks to its suppliers the same day that totaled $20,000. If $14,000 of the firm’s deposited checks have cleared by the end of the third day but only $8,000 of its checks to suppliers have cleared, what is its “float”?

a. $14,000

b. $28,000

c. $36,000

d. $41,000

Difficulty: Moderate

Keywords: float

150. Banker’s acceptances are:

a. not issued in specialized denominations.

b. fully taxable at the federal, state, and local levels.

c. are sold on a discount basis and payable to the bearer.

d. all of the above.

Difficulty: Moderate

Keywords: banker’s acceptances

151. Which of the following statements is a good working definition of money market funds?

a. Money market funds are accounts that allow small investors to buy shares in companies that use the investors’ money to buy shares of common stock.

b. Money market funds are risky accounts but they generate high yields.

c. Money market funds are accounts that contain a portion of a pool of long-term corporate bonds.

d. Money market funds are accounts that allow small investors to participate by proportion in purchasing large-denomination securities such as negotiable CDs issued by large money center banks.

Difficulty: Moderate

Keywords: money market funds

152. In order to select a proper marketable securities mix, the financial manager should evaluate:

a. financial and interest rate risk.

b. liquidity and taxability.

c. yields among different financial assets.

d. all of the above.

e. none of the above.

Difficulty: Moderate

Keywords: financial manager, marketable securities portfolio

153. Which of the following is not a good reason for holding cash rather than marketable securities? Cash is held:

a. to meet daily business transaction needs.

b. to provide the CEO with a travel slush fund.

c. when yields on marketable securities are so low that brokerage costs would nearly eat up the entire yield.

d. to make the balance sheet look good.

Difficulty: Moderate

Keywords: motives for cash holdings

154. The benefits of a lock box arrangement include:

a. increased working cash.

b. better safekeeping of checks.

c. higher interest rates.

d. more favorable purchase discounts.

Difficulty: Moderate

Keywords: lock box system

155. Why might a U.S. multinational company [MNC] prefer to hold sizeable cash balances in the currency of one of its foreign subsidiaries rather than in U.S. dollars?

a. The subsidiary’s country’s interest rates on marketable securities are better than those available in U.S. dollars in the U.S., even though the government in the foreign country is very unstable.

b. The subsidiary’s country’s currency might be expected to appreciate relative to the U.S. dollar.

c. The U.S. MNC always would prefer to hold its cash in U.S. dollars.

d. The U.S. MNC should have an ample supply of the foreign currency so that the managers of its subsidiary can offer the expected gratuities to the foreign officials.

Difficulty: Moderate

Keywords: multinational firms and cash balances

156. Which of the following statements is a good working definition of a eurodollar CD?

a. A eurodollar CD represents U.S. dollars on deposit in a non-U.S. bank that may be loaned to anyone who wishes to hold U.S. dollars.

b. A eurodollar CD represents U.S. dollars that have been converted into a European currency.

c. A eurodollar CD can only be redeemed at the European branches of a U.S. bank.

d. A eurodollar CD represents U.S. dollars on deposit only in banks registered in European Union countries.

Difficulty: Moderate

Keywords: eurodollar certificate of deposit

157. What is a “CD”?

a. A negotiable certificate of deposit

b. A corporate controlled disbursement account

c. A commercial demand deposit

d. A certified disbursement

Difficulty: Easy

Keywords: negotiable certificate of deposit

158. The firm’s cash balance experiences reductions to:

a. invest excess cash in near-cash assets.

b. make required payments such as interest on debt.

c. purchase inventories.

d. all of the above.

Difficulty: Easy

Keywords: cash balance reductions

159. Which of the following statements about the motives for holding cash is true?

a. Precautionary balances are a buffer stock of liquid assets.

b. Cash is held for precautionary purposes in order to take advantage of potential profit-making situations.

c. The transactions and speculative motives account for most of the reasons why a company holds cash balances.

d. Returns on cash investments exceed the expected returns of other assets.

Difficulty: Moderate

Keywords: motives for holding cash

160. Float can be described as:

a. mail float, which is caused by the time lapse from when a customer mails a remittance check until the firm’s bank deposits funds in the firm’s account.

b. processing float, which is caused by the time necessary for a deposited check to clear through the commercial banking system and become usable funds to the firm.

c. transit float, which is caused by the time required for the firm to process remittance checks before they can be deposited in the bank.

d. disbursing float, which derives from the fact that funds are available in the firm’s bank account until its payment check has cleared through the banking system.

Difficulty: Moderate

Keywords: float

Use the following information to answer questions 164-167. Epsilon Corp. has total revenues of $50 million and typically earns an annual return of 5% on short-term investments.

161. The amount of usable funds Epsilon would release if it could achieve a one-day reduction in float is about:

a. $136,986.

b. $172,602.

c. $250,897.

d. $275,987.

Difficulty: Moderate

Keywords: reduction of float

162. If Epsilon can invest the released funds for a year, then the annual value of the one-day float reduction would be:

a. $10,799.

b. $8,545.

c. $6,849.

d. $4,630.

Difficulty: Moderate

Keywords: reduction of float

163. If Epsilon started using a lock box system that is expected to speed up its cash collections by four days, then the gross annual savings to Epsilon would be:

a. $34,520.

b. $27,397.

c. $21,179.

d. $15,196.

Difficulty: Moderate

Keywords: lock box system

164. If Epsilon adopts a lock box system, its check processing cost will rise by $0.15 a check. Epsilon has determined that the average check size that will be mailed to the lock box location is $750. If Epsilon feels that, realistically, the lock box system will speed up its collections by 1.25 days, then:

a. Epsilon should use the lock box system.

b. Epsilon should not use the lock box system.

c. Epsilon will be indifferent between adopting and not adopting the lock box system.

d. we do not have enough information to determine what Epsilon should do.

Difficulty: Moderate

Keywords: lock box system

165. The benefits of a lock box arrangement include:

a. increased working cash.

b. elimination of clerical functions.

c. early knowledge of dishonored checks.

d. all of the above.

Difficulty: Easy

Keywords: lock box system

166. Which of the following is not a good business practice for speeding up the collection of accounts receivable?

a. Offering reasonable discounts to customers for early payment.

b. A system of regional collection centers.

c. Slowing down payments to a firm’s suppliers to match the speed of the collections of the firm’s accounts receivable.

d. A lock box system.

Difficulty: Moderate

Keywords: collection of accounts receivable

167. Wire transfers:

a. eliminate disbursing float.

b. eliminate processing float.

c. are a relatively expensive method of cash management.

d. are the same as payable-through drafts.

Difficulty: Moderate

Keywords: wire transfers

168. Zero balance accounts are:

a. for the firm to achieve better control over its cash payments.

b. to increase cash balances held in regional banks for disbursing purposes.

c. to decrease disbursing float.

d. are only allowed if a firm’s average cash balance is greater than $1 million.

Difficulty: Moderate

Keywords: zero balance accounts

169. Sigma, Inc. is assessing whether it should adopt a lock box system. Sigma knows that its check processing cost will rise by $0.15 a check if it adopts the system. In addition, Sigma has determined that the average check size that will be mailed to the lock box location is $750. Sigma will invest funds which are freed by use of the lock box in marketable securities to yield an annual before-tax return of 5%. The lock box is justified if Sigma can speed up its collections by a minimum of:

a. 1.14 days.

b. 1.46 days.

c. 2.63 days.

d. 2.88 days.

Difficulty: Moderate

Keywords: lock box system

170. Which of the following statements about marketable security alternatives is true?

a. Negotiable certificates of deposit are the best-known and most popular short-term investment outlet among firms.

b. Federal agency securities are debt obligations of corporations and agencies that are owned by the United States Government.

c. Banker’s acceptances’ part in United States commerce today is largely concentrated in the financing of foreign transactions.

d. Banker’s acceptances arise out of repurchase agreements.

Difficulty: Moderate

Keywords: banker’s acceptance

171. Which of the following are valid reasons for a business to hold cash?

a. To have funds available if some unforeseen event occurs.

b. In order to pay dividends to common stockholders when they become payable.

c. In order to pay for the purchase of raw materials.

d. All of the above.

e. None of the above.

Difficulty: Moderate

Keywords: motives for holding cash

172. Businesses hold cash in order to:

a. make depreciation payments when they become due.

b. take advantage of potential profit-making situations.

c. make accrual payments.

d. improve cash flow.

Difficulty: Moderate

Keywords: motives for holding cash

173. Which of the following will be the most adversely affected if a firm maintains excessive idle cash balances?

a. The debt ratio

b. The quick ratio

c. The capital asset pricing model (CAPM)

d. Return on investment

e. Inventory turnover

Difficulty: Moderate

Keywords: excessive cash balances

174. Insolvency occurs when a firm is unable to:

a. borrow money from its bank.

b. pay its bills.

c. issue dividends to common stockholders.

d. both a and b.

e. all of the above.

Difficulty: Moderate

Keywords: insolvency

175. A lock box plan is a way of:

a. delaying the payment of checks written by a firm.

b. speeding up the collection and clearing of checks received by a firm from the collection of its accounts receivable.

c. safeguarding cash held by a firm.

d. hiding cash from the IRS.

Difficulty: Moderate

Keywords: lock box system

176. Which of the following best describes float when used in the context of managing current assets?

a. Determining the optimum level of inventory that a firm should float on its balance sheet

b. The period of time that the Federal Reserve allows banks from the time they make a loan until they are required to report it as an asset on their books

c. The period of time that elapses from the time a check is written until the recipient can use the funds

d. The grace period that banks allow their customers

Difficulty: Moderate

Keywords: float

177. Which of the following can accurately be considered as an element of float?

a. Mail time

b. Processing checks for deposit

c. Transit, or check clearing, time

d. All of the above

e. None of the above

Difficulty: Moderate

Keywords: elements of float

178. Which of the following represent acceptable methods of improving a firm’s float?

a. Depository transfer checks

b. Lock boxes

c. Preauthorized checks

d. Wire transfers

e. All of the above

Difficulty: Moderate

Keywords: improving float

179. Macro Giant generates $5 billion in annual sales. The firm collects its accounts receivable in 47 days on average throughout the year. Macro has a line of credit at numerous banks where it borrows at 7.75%. A study has shown that Macro could implement a new collection program that will allow the firm to collect receivables in 45 days versus the present 47 days. If Macro were to implement the program and use the collected funds to reduce its line of credit by the same amount, how much would Macro save in annual interest expense? Assume a 365-day year.

a. $1.7 million

b. $2.1 million

c. $3.2 million

d. $4.1 million

e. $5.8 million

Difficulty: Moderate

Keywords: annual interest expense

180. Letni generates $3 billion in annual sales. The firm maintains accounts at various banking institutions throughout the world. Letni is considering the implementation of a new cash management program that will allow the firm to invest excess cash balances sooner than its present system. The firm has calculated that its excess cash balances are equal to five days’ sales. If Letni were to implement the program and earn 4.25% on the freed-up funds, how much would Letni earn annually as a result? Assume a 365-day year.

a. $1.7 million

b. $2.2 million

c. $3.4 million

d. $4.6 million

e. $5.1 million

Difficulty: Moderate

Keywords: excess cash balances

181. A zero balance account would allow a firm to:

a. reduce its return on investment.

b. maintain centralized control over cash outflows.

c. collect its checks faster.

d. avoid compensating balance requirements.

Difficulty: Moderate

Keywords: zero balances account

182. Which of the following will accomplish objectives for a firm that are consistent with the time value of money?

a. Remote disbursements

b. Payable-through drafts

c. Wire transfers

d. All of the above

e. None of the above

Difficulty: Moderate

Keywords: time value of money

183. ____________ are used by exporters in order to obtain payment for goods shipped to a customer who maintains an account at a specific bank.

a. Banker’s acceptances

b. Repurchase agreements

1. Commercial paper
2. Preauthorized transactions

Difficulty: Moderate

Keywords: banker’s acceptances

184. Which of the following factors influences the choice of marketable securities that a firm would invest its excess cash balances in?

a. Interest rate risk

b. Liquidity

c. Yield

d. All of the above

Difficulty: Easy

Keywords: factors influencing marketable securities portfolio

185. Earnings on U.S. Treasury bills consist of purchasing the Treasury bill at a discount and having it redeemed at face value. If a firm purchases a $100,000 Treasury bill for $94,990 and holds it until maturity six months later, what is the annual rate of interest earned on the investment?

a. 6.49%

b. 5.21%

c. 4.33%

d. 3.60%

e. 2.01%

Difficulty: Moderate

Keywords: annual rate of interest

186. Enzyme Drug Company is considering the merits of investing temporarily excess cash balances in either 90-day U.S. Treasury bills or one-year U.S. Treasury notes. If market interest rates rise over the next year, both investments will decline in value if they are sold prior to their maturity. This previous illustration represents an example of which of the following?

a. Financial risk

b. Purchasing power parity

c. Floatation risk

d. Interest rate risk

Difficulty: Moderate

Keywords: excess cash balance

187. Power Line Sports is analyzing its investment opportunities and has narrowed them down to several choices. One alternative has caught the eye of the controller. It is a tax anticipation note that comes due in one year. It is presently paying 8.45% interest per annum. If Power Line’s income tax rate is 40%, what is the after-tax yield of the note?

a. 7.45%

b. 6.66%

c. 5.07%

d. 4.50%

e. 3.38%

Difficulty: Moderate

Keywords: after-tax yield

188. Which of the following is the most important consideration regarding the investment of temporarily excess cash balances?

a. Create the greatest tax shelter.

b. Maximize the rate of return on the investment regardless of risk.

c. Optimize the rate of return that is commensurate with the level of risk that the firm should be exposed to.

d. Maximize leverage.

e. Generate maximum brokerage fees for your friends.

Difficulty: Moderate

Keywords: excess cash balances

189. Which of the following investments does not properly meet the objectives of investing temporarily excess cash balances?

a. Commercial paper

b. Real estate development projects

c. U.S. Treasury bills

d. Repurchase agreements

e. Banker’s acceptances

Difficulty: Moderate

Keywords: excess cash balances

190. Which of the following provides the best after-tax return to a firm? For purposes of this question, disregard the differences in the amounts, maturities, and risk of the investment alternatives; i.e., focus only on the annualized after-tax rate of return. Assume a 365-day year and a 40% tax rate.

a. A one-year $10,000 fully taxable U.S. Treasury note purchased for $9,500.

b. Fully taxable commercial paper purchased for $92,500, which will mature in one year for $100,000.

1. A $50,000 face value one-year tax-exempt municipal note that yields 5.10% before tax.
2. A one-year tax-exempt municipal that yields 4% before tax.

Difficulty: Moderate

Keywords: after-tax returns

Short Answer

191. Describe the risk-return trade-off that exists in cash management.

Difficulty: Easy

Keywords: cash management, risk-return trade-off

192. Discuss how the multinational firm differs from the domestic firm in the utilization of cash and marketable securities.

Difficulty: Easy

Keywords: actual cash management practices

193. Colonial Services has received a proposal from Tidewater Bankshares to establish a lock box system to accelerate the receipt of $500 million annually on one million checks. By its own analysis, Petro believes such a system would decrease total float by two days. If Petro can earn 12% before taxes on the released funds, what is the maximum that Colonial should be willing to pay the bank per check for the service? Use a 365-day year.

P = (2.0)[($500 million)(.12)]/[(1 million)(365)] = $0.329

Difficulty: Moderate

Keywords: lock box system

194. Bonnie’s Fashions is a national distributor of women’s apparel. The company expects to receive 60,000 checks during the coming year totaling $48 million. A large bank has offered to install a lock box system at a charge of $0.35 per processed check. If Bonnie’s Fashions is able to earn 12% before tax on additional funds, what is the minimum amount of total float days that must be saved to make the system worthwhile? Use a 365-day year.

0.35TF = 1.33 days =

TF × [($48 million)(.12)]/[(60,000)(365)]

Difficulty: Moderate

Keywords: lock box system

195. Ruth’s Cosmetics expects to have $30 million in credit sales during the coming year. In spite of a national distributing system, all remittances are sent to the home office. A proposed system can eliminate three days of float, releasing funds which, when invested, will earn 11%. What annual savings can Ruth’s Cosmetics expect if the system is implemented? Use a 365-day year.

Difficulty: Moderate

Keywords: float

196. Elke’s Pet Supplies earns 12% on its investment in marketable securities. A draft disbursing system has been proposed that will increase disbursement float by two days. Purchases next year are expected to total $6 million. Individual payments average $600. Use a 365-day year.

a. If the draft system is adopted, what amount of funds can the firm expect to release during the year?

b. If each issue draft costs the firm $0.10, should the draft system be adopted?

c. Should the firm consider any other factors?

a. ($6,000,000/365)(2.0) = $32,877.

b. ($16,438/$600) = 27.4 drafts issued daily

Total annual cost of drafts = (27.4)(365)($0.10) = $1,000

Interest gained on released funds = $32,877(0.12) = $3,945

Yes. The draft system should be accepted because the interest of $3,945 gained on the released funds is greater than the $1,000 cost of the system.

c. Those firms receiving payment by means of the draft might prefer another method of payment.

Difficulty: Moderate

Keywords: float

197. Eskimo Mining expects to have credit sales of $5 million this year. First National Bank is offering Eskimo Mining a lock box system for $1,000 per month. Eskimo Mining estimates that the new lock box system will reduce float by five days. What rate of return must Eskimo Mining earn on its marketable securities to make it worthwhile for the company to institute this lock box system? Use a 365-day year.

Rate of return earned on marketable securities

Income = ($5,000,000/365 days) × 5 days × rate = $1,000 × 12

Rate of return = $12,000/[($5,000,000/365) × 5] = $12,000/$68,493 = .1752

Difficulty: Moderate

Keywords: lock box system

198. Carrollton Plumbing Supplies expects total sales of $7 million this year. 10% of the company’s sales are paid in cash; credit sales are usually paid by check. The average check size is $1,000. Second National Bank is offering the company a lock box system. The fees are $500 per month plus $.50 per check. Short-term marketable securities are currently earning 12% per year. What reduction in check collection time is necessary for Carrollton Plumbing Supplies to be neither better nor worse off from adopting the proposed system? Use a 365-day year.

CTIME = reduction in check collection time

Credit sales = (.90)($7,000,000) = $6,300,000

Average number of checks received = $6,300,000/$1,000 = $6,300

($6,300,000/365) × CTIME × .12 = $500 × 12 + ($.50)($6,300)

CTIME = ($6,000 + $3,150)/[($6,300,000/365) × .12] = $9,150/$2,071 = 4.418 days

Difficulty: Moderate

Keywords: lock box system

199. Three years ago, the treasurer of Hokie Autos purchased a 10-year bond for $1,000 that pays $80 in interest once each year. Today, bonds of similar risk and maturity are yielding 10%. If the old bond is sold today, what would be the gain or loss over the original purchase price of $1,000?

$80(4.868) + $1000(.513) = $902.44.

Loss = $1,000 - $902.44 = $97.56.

Difficulty: Moderate

Keywords: loss on bonds

200. The treasurer of Zeta Graphics is contemplating the purchase of one of two bonds, both with a face value of $1,000. One of the bonds is a 10-year corporate bond paying $80 once each year and selling today for $1,000. The second bond, a municipal, also matures in 10 years and yields 6 1/2%. If Zeta Graphics is in the 40% tax bracket, which bond should the treasurer purchase?

The before-tax yield on the corporate bond is 8%. The equivalent before-tax yield on a municipal bond is: .065/(1 - .40) = 0.108 = 10.83 percent

The municipal bond has the higher yield.

Difficulty: Moderate

Keywords: before-tax equivalent yield

201. You have a choice between investing in a corporate bond or a municipal bond. The corporate bond has an annual yield of 14%, while the municipal bond has an annual yield of 11%. At what tax rate would you be indifferent between buying the corporate bond or the municipal bond?

Before-tax equivalent yield on municipal bond = .110/(1 - tax rate)

Before-tax yield on corporate bond = .140

.140 = .110/(1 - tax rate)

(.140)(1 - tax rate) = .110

(1 - tax rate) = (.110/.140) = .7857

tax rate = .2143

Difficulty: Moderate

Keywords: before-tax equivalent yield

202. Carraway Seed Sales, Inc. expects to generate sales of $18 million in the coming year. All sales are done on a credit basis, net 30 days. Carraway has estimated that it takes an average of three days for payments to reach their central office and an additional day to process the payments. What is the opportunity cost of the funds tied up in the mail and processing? Carraway uses a 360-day year in all calculations and can invest free funds at 8%.

Daily collections = $18,000,000/360 = $50,000

Opportunity cost = (50,000)(4)(.08) = $16,000

Difficulty: Moderate

Keywords: opportunity cost of funds

203. The corporate treasurer of Sid’s Flowers, Inc. is considering the purchase of either a municipal obligation with a 6.6% coupon or an offering carrying a 10% coupon. Both bonds have a $1,000 par value. The company is currently in the 34% marginal tax bracket. Which security should the treasurer recommend?

Difficulty: Moderate

Keywords: after-tax yield

204. Omega Art Supply expects to have $50 million in credit sales during the coming year. In spite of a national distributing system, all remittances are sent to the home office. A proposed system can eliminate two days of float, releasing funds which, when invested, will earn 9%. What annual savings can Omega expect if the system is implemented? Use a 365-day year.

Difficulty: Moderate

Keywords: elimination of float

205. The treasurer of Beta Electronics is contemplating the purchase of one of two bonds, both with a face value of $1,000. One of the bonds is a 20-year corporate bond paying $90 once each year and selling today for $1,000. The second bond, a municipal, also matures in 20 years and yields 5 1/2%. If Beta Electronics is in the 35% tax bracket, which bond should the treasurer purchase?

The before-tax yield on the corporate bond is 9%.

The equivalent before-tax yield on a municipal bond is:

0.055/(1 - 0.35) = 0.085 = 8.5%

The corporate bond has the higher yield.

Difficulty: Moderate

Keywords: before-tax equivalent yield

206. During the next three months, Mid-City Distributors plans to make payments of $200,000. The company currently has the $200,000 invested in marketable securities. The marketable securities earn 8% per year. The fixed cost per order of converting marketable securities into cash is $50. If the company follows the Baumol cash management model, what is the total cost of having cash on hand?

TC = (0.02)($31,623/2) + $50($200,000/$31,623)

= (0.02)$15,811 + $50(6.3245) = 316.22 + 316.23

= $632.45

Difficulty: Moderate

Keywords: cash management, cash on hand