Chapter 16
Short-Term Business Financing

TRUE-FALSE QUESTIONS

1. Working capital includes a firm’s marketable securities, accounts receivable, inventories, and mortgage debt.

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

2. The choice of financing strategy involves a tradeoff between return and risk.

Difficulty Level: Easy

Subject Heading: Conservative Approach

L.O. 16.1

3. Using the conservative approach for financing a firm’s assets, long term financing would be used only to finance fixed assets, while short term financing would be used to finance current assets including seasonal fluctuations.

Difficulty Level: Medium

Subject Heading: Conservative Approach

L.O. 16.1

4. Using aggressive approach for financing a firm’s assets, long term financing would be used only to finance fixed assets, while short term financing would be used to finance current assets including seasonal fluctuations.

Difficulty Level: Medium

Subject Heading: Aggressive Approach

L.O. 16.1

5. The conservative financing approach is a strategy that attempts to match the maturities of assets with the maturities of the liabilities with which they are financed.

Difficulty Level: Medium

Subject Heading: Conservative Approach

L.O. 16.1

6. The aggressive financing approach is a strategy that attempts to match the maturities of assets with the maturities of the liabilities with which they are financed.

Difficulty Level: Medium

Subject Heading: Aggressive Approach

L.O. 16.1

7. If net working capital is negative, current assets are partially financed by the firm’s long-term debt.

Difficulty Level: Medium

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

8. Permanent current assets reflect the minimum investment level in cash, accounts receivable, and inventories needed to support sales.

Difficulty Level: Medium

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

9. The maturity matching approach is a financing strategy that attempts to match the maturities of assets with the maturities of the liabilities which they are financed.

Difficulty Level: Medium

Subject Heading: Maturity-Matching Approach

L.O. 16.1

10. Firms using maturity matching will have current ratios equal to 1.0.

Difficulty Level: Medium

Subject Heading: Maturity-Matching Approach

L.O. 16.1

11. An aggressive financing plan has a higher financing cost, but with lower risk of not being able to borrow when short-term funds are needed.

Difficulty Level: Medium

Subject Heading: Aggressive Approach

L.O. 16.1

12. Short-term financing sources include bank loans, trade credit, and commercial paper.

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

13. A firm’s choice of financing strategy depends on a number of factors including its operating characteristics, cost, flexibility, and the ease of obtaining future financing.

Difficulty Level: Medium

Subject Heading: Factors Affecting Short-Term Financing

L.O. 16.2

14. Service industries tend to have larger proportions of fixed assets to current assets.

Difficulty Level: Medium

Subject Heading: Factors Affecting Short-Term Financing

L.O. 16.2

15. Short-term financing offers greater flexibility than long-term financing.

Difficulty Level: Easy

Subject Heading: Other Influences in Short-Term Financing

L.O. 16.2

16. The need for current funds increases when there is an upswing in the business cycle or the sales cycle of an industry.

Difficulty Level: Medium

Subject Heading: Operating Characteristics

L.O. 16.2

17. The prime rate is the interest rate the bank charges its most creditworthy customers.

Difficulty Level: Easy

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

18. A line of credit is also often referred to as a revolving credit agreement.

Difficulty Level: Easy

Subject Heading: Bank Lines of Credit

L.O. 16.3

19. An advantage of short-term borrowing is the need for frequent renewals.

Difficulty Level: Medium

Subject Heading: Other Influences in Short-Term Financing

L.O. 16.3

20. A line of credit costs the firm only the normal interest for the period during which money is actually borrowed.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

21. A line of credit is a legal obligation of the bank to provide funds up to the agreed-upon borrowing limit for a period of time.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

22. A revolving credit agreement is a commitment in the form of a standby agreement for a guaranteed line of credit.

Difficulty Level: Easy

Subject Heading: Revolving Credit Agreements

LO 16.3

23. Discounting has the effect of reducing the available funds received by the borrower while raising the effective interest rate.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

24. A compensating balance requirement means that a lending institution will require a borrowing company to keep a certain percentage of the loaned amount on deposit with that institution.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

25. Compensating balances decrease the effective cost of borrowing.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

26. A discounted loan is one in which the borrower receives the principal plus the interest at the time the loan is made.

Difficulty Level: Easy

Subject Heading: Computing Interest Rates

L.O. 16.3

27. A discounted loan is one in which the borrower receives a discount on the interest rate.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

28. To compute the effective cost of a revolving agreement, the joint effect of interest on borrowed funds and commitment fees must be considered.

Difficulty Level: Medium

Subject Heading: Revolving Credit Agreements

L.O. 16.3

29. When a loan is discounted, to receive the desired usable funds, the loan request must equal Desired usable funds x (1 – Discount).

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

30. For compensating balance loans, to receive the desired usable funds, the loan request must equal Desired usable funds x (1 – Compensating balance requirement).

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

31. The U.S. Small Business Administration (SBA) was established by the federal government to provide financial assistance to small firms unable to obtain loans through direct government loans.

Difficulty Level: Easy

Subject Heading: Small Business Administration

L.O. 16.3

32. In general, most businesses should take advantage of a cash discount of 2/10 net 30 because the cost of not doing so is more expensive than the cost of borrowing.

Difficulty Level: Medium

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

33. Trade credit is the single most important form of short-term business financing.

Difficulty Level: Easy

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

34. Short-term financing may come in the form of trade credit extended between businesses.

Difficulty Level: Medium

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

35. A commercial finance company typically purchases the accounts receivable outright and assumes all credit risks.

Difficulty Level: Medium

Subject Heading: Commercial Finance Companies

L.O. 16.4

36. Trade credit may be considered the least formal of all forms of financing.

Difficulty Level: Medium

Subject Heading: Trade Credit Financing

L.O. 16.4

37. An acceptance is a receivable from the sale of merchandise on the basis of a draft or bill of exchange drawn against the buyer or the buyer’s bank.

Difficulty Level: Medium

Subject Heading: Acceptances

L.O. 16.5

38. A factor engages in accounts receivable financing for business by purchasing accounts outright and assuming all credit risks.

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

39. A factor engages in accounts receivable financing for business by taking accounts receivable as collateral for making short-term loans.

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

40. Maturity factoring is where the firm selling its accounts receivable is paid on the normal collection date or net due date of the account.

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

41. When accounts receivable are factored: money is advanced to the borrower as a loan against accounts receivable; accounts receivable balances remain on the balance sheet; the customer payment is made to the firm, which then submits the payment to the bank; and interest is charged on the loan.

Difficulty Level: Hard

Subject Heading: Accounts Receivable Financing

L.O. 16.5

42. When accounts receivable are factored: the borrower sells the receivable; accounts receivable balances are removed from the balance sheet; the customer payment is made to the factor; and interest is charged on the funds advanced.

Difficulty Level: Hard

Subject Heading: Accounts Receivable Financing

L.O. 16.5

43. If a borrowing firm does not qualify for an unsecured bank loan and pledges its accounts receivable as security, it eliminates the need for a credit investigation.

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

44. If a borrowing firm does not qualify for an unsecured bank loan and pledges its accounts receivable as security, it must execute an assignment of these accounts to the bank.

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

45. When accounts receivable are pledged: money is advanced to the borrower as a loan against accounts receivable; accounts receivable balances remain on the balance sheet; the customer payment is made to the firm, which then submits the payment to the bank; and interest is charged on the loan.

Difficulty Level: Hard

Subject Heading: Accounts Receivable Financing

L.O. 16.5

46. Advance factoring is where the firm selling its accounts receivable is paid on the normal collection date or net due date of the account.

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

47. A trust receipt is a claim against a customer’s inventory when the individual items are indistinguishable.

Difficulty Level: Medium

Subject Heading: Inventory Loans

L.O. 16.6

48. Inventory loans are less expensive than unsecured loans to business borrowers.

Difficulty Level: Medium

Subject Heading: Inventory Loans

L.O. 16.6

49. Stocks and bonds are rarely used as collateral for short-term loans.

Difficulty Level: Medium

Subject Heading: Loans Secured by Stocks and Bonds

L.O. 16.6

50. An owner of a business may not assign life insurance as collateral for a short-term loan.

Difficulty Level: Medium

Subject Heading: Other Forms of Security for Loans

L.O. 16.6

51. A claim against an inventory when individual items are indistinguishable is called a complete inventory lien.

Difficulty Level: Easy

Subject Heading: Inventory Loans

L.O. 16.6

52. A trust receipt is a lien against everything in inventory.

Difficulty Level: Easy

Subject Heading: Inventory Loans

L.O. 16.6

53. With a trust receipt lean, the bank retains ownership of the goods until they are sold in the regular course of business.

Difficulty Level: Easy

Subject Heading: Inventory Loans

L.O. 16.6

54. A field warehouse is a warehouse on the grounds of the borrowing business establishment.

Difficulty Level: Easy

Subject Heading: Inventory Loans

L.O. 16.6

55. The practice of compensating balances is diminishing.

Difficulty Level: Easy

Subject Heading: Bank Lines of Credit

L.O. 16.3

56. With accounting factoring, the factor assumes all credit risk on accounts receivable.

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

57. Grain would be a type of inventory for which a blanket inventory lien would be used.

Difficulty Level: Hard

Subject Heading: Inventory Loans

L.O. 16.6

58. New cars would be a type of inventory for which a blanket inventory lien would be used.

Difficulty Level: Hard

Subject Heading: Inventory Loans

L.O. 16.6

59. Tea leaves would be a type of inventory for which a blanket inventory lien would be used.

Difficulty Level: Hard

Subject Heading: Inventory Loans

L.O. 16.6

60. New cars would be a type of inventory for which a trust receipt would be used.

Difficulty Level: Hard

Subject Heading: Inventory Loans

L.O. 16.6

61. Tea leaves would be a type of inventory for which a trust receipt would be used.

Difficulty Level: Hard

Subject Heading: Inventory Loans

L.O. 16.6

MULTIPLE-CHOICE QUESTIONS

62. If a firm has positive net working capital, the current ratio is:

a. greater than one

b. less than one

c. equal to one

d. between zero and one

Difficulty Level: Easy

Subject Heading: Aggressive Approach

L.O. 16.1

63. Net working capital is defined as:

a. current assets plus current liabilities

b. current assets less fixed assets

c. current assets less current liabilities

d. current liabilities plus long-term liabilities

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

64. Permanent current assets are:

a. accounts receivable that have become bad debts

b. inventories that have become obsolete

c. the level of current assets equal to fixed assets

d. the level of current assets needed to support sales

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

65. Which of the following are typical financing strategies used by businesses?

a. maturity matching, aggressive financing, and conservative financing

b. size matching, aggressive financing, and aggressive financing

c. maturity matching, size matching, and aggressive financing

d. maturity matching, size matching, and conservative financing

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

66. For most lines of business the basic source of short-term loan financing is:

a. commercial banks

b. finance companies

c. the commercial paper market

d. factors

Difficulty Level: Medium

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

67. If net working capital is negative:

a. current assets are greater than current liabilities

b. it represents the portion of fixed assets that are financed through long-term financing

c. it represents the portion of fixed assets that are financed by current liabilities

d. none of the above

Difficulty Level: Medium

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

68. If total assets are $100,000, fixed assets are $30,000, current liabilities are $20,000, then net working capital is:

a. $100,000

b. $70,000

c. $50,000

d. $0

Difficulty Level: Medium

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

69. Higher financing cost and lower risk of not being able to borrow when short-term funds are needed are characteristics of:

a. aggressive financing

b. conservative financing

c. maturity matching

d. term borrowing

Difficulty Level: Medium

Subject Heading: Conservative Approach

L.O. 16.1

70. Spontaneous financing refers to:

a. financing provided by accounts payable and accrued liabilities

b. line of credit agreements

c. revolving credit agreements

d. financing done without collateral

Difficulty Level: Easy

Subject Heading: Conservative Approach

L.O. 16.1

71. When old short-term debt is replaced by new short-term debt as the old debt comes due, the process is known as:

a. compensating balance

b. rolling the debt

c. fluctuating financing

d. re-terming

Difficulty Level: Medium

Subject Heading: Conservative Approach

L.O. 16.1

72. The largest providers of short-term financing are:

a. commercial banks

b. commercial finance companies

c. factors

d. commercial paper issuers

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

73. A firm’s current assets.

a. Working liabilities

b. Current liabilities

c. Working capital

d. Net working capital

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

74. Cash, marketable securities, accounts receivable, and inventories.

a. Working liabilities

b. Current liabilities

c. Working capital

d. Net working capital

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

75. Current assets less current liabilities.

a. Working liabilities

b. Long-term liabilities

c. Working capital

d. Net working capital

Difficulty Level: Easy

Subject Heading: Strategies for Financing Working Capital

L.O. 16.1

76. Which of the following operating characteristics does not affect a firm’s short-term financing strategy?

a. industry and company factors

b. seasonal variation

c. fixed asset investments

d. cyclical variations

Difficulty Level: Easy

Subject Heading: Factors Affecting Short-Term Financing

L.O. 16.2

77. An influence that affects the selection of a short-term financing strategy includes:

a. cost

b. market risk

c. term risk

d. arbitrage

Difficulty Level: Medium

Subject Heading: Factors Affecting Short-Term Financing

L.O. 16.2

78. In general, short-term self-liquidating bank loans are intended to:

a. help recapitalize a company.

b. help a company finance merger & acquisitions.

c. help a company finance seasonal inventory and accounts receivable requirements.

d. help a company finance investment in capital assets.

Difficulty Level: Medium

Subject Heading: Operating Characteristics

L.O. 16.2

79. The bank line of credit is:

a. the type of business activity on which a particular bank concentrates its lending

b. the maximum amount of credit extended to a business customer during a period of one year

c. the average of loans made to a business customer during a year

d. the loan limit that a bank has established for a business customer

Difficulty Level: Easy

Subject Heading: Bank Lines of Credit

L.O. 16.3

80. Compensating balances at a commercial bank are:

a. net differentials of balances with correspondent banks

b. maintained by Federal Reserve for services rendered

c. account balances required in connection with unsecured business loans under bank lines of credit

d. required vault-held reserves as an alternative to reserves held by Federal Reserve Banks

Difficulty Level: Easy

Subject Heading: Bank Lines of Credit

L.O. 16.3

81. A revolving credit agreement is a:

a. banker’s agreement to extend the maturity of a loan

b. banker’s standby agreement to provide a guaranteed line of credit for a specified period of time

c. large loan supported by a group of banks on an alternating basis

d. loan arrangement with a bank whereby secured and unsecured loans are alternately used

Difficulty Level: Easy

Subject Heading: Revolving Credit Agreement

L.O. 16.3

82. A short-term bank loan that is unsecured is referred to as:

a. a line of credit

b. an accounts-receivable loan

c. an inventory loan

d. a life insurance policy loan

Difficulty Level: Easy

Subject Heading: Bank Lines of Credit

L.O. 16.3

83. The prime rate offered by commercial banks is their _____________ rate to their ______________ quality business customers.

a. highest, highest

b. lowest, lowest

c. lowest, highest

d. highest, lowest

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

84. In order to borrow $100,000 for a 10% loan on discount basis, the firm will actually have to borrow:

a. $110,000

b. $111,111

c. $100,000

d. $90,000

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

85. In order to borrow $100,000 for a 5% loan on a discount loan basis with a 5% compensating balance; the firm will actually have to borrow:

a. $105,263

b. $111,111

c. $100,000

d. $90,000

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

86. In order to borrow $175,000 for an 8% loan on discount basis, the firm will actually have to borrow:

a. $162,037

b. $175,000

c. $189,000

d. $190.217

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

87. In order to borrow $2,225,000 for a 7.5% loan on discount basis, the firm will actually have to borrow:

a. $2,069,767

b. $2,391,875

c. $2,406,405

d. $2,571,266

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

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

a. prime rate

b. commercial paper rate

c. federal funds rate

d. treasury bill rate

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

89. The prime rate is:

a. the highest rate of interest charged on business loans to the best business borrowers by the nation's leading banks’ premium rate

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

c. the average rate of interest charged on business loans to the best business borrowers by the nation's leading banks.

d. the treasury bill rate

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

90. Commercial banks lend unsecured short-term funds in the following three basic ways:

a. Commercial paper, lines of credit, and revolving credit agreements.

b. Single-payment note, revolving credit agreements, and commercial paper.

c. Single-payment note, lines of credit, and revolving credit agreements.

d. Commercial paper, lines of credit, and compensating balances.

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

91. Commercial banks lend unsecured short-term funds in the following three basic ways:

a. Commercial paper, lines of credit, and revolving credit agreements.

b. Single-payment note, revolving credit agreements, and revolving credit agreements.

c. Single-payment note, lines of credit, and trade credit agreements.

d. trade, lines of credit, and revolving compensating balances.

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.3

92. In general, a firm that secures a bank line of credit pays interest on:

a. the full line of credit.

b. only the amount actually borrowed.

c. on the unused portion of the line of credit.

d. on the amount borrowed as well as on the unused portion of the line of credit.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

93. In general, a firm that secures a bank line of credit pays interest on:

a. the full line of credit.

b. only half of the amount actually borrowed.

c. on the unused portion of the line of credit.

d. on the amount actually borrowed.

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

L.O. 16.3

94. Bank loans on which interest is paid up front in advance are called:

a. discount loans.

b. build-up loans

c. advance interest loans.

d. revolving credit agreements.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

95. For bank loans, the effective interest rate is generally

a. not affected by whether or not the loan is a discount loan or a traditional loan.

b. higher if the loan is a discount loan.

c. lower if the loan is a discount loan.

d. higher if the interest is paid at maturity.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

96. For bank loans, the effective cost is generally

a. not affected by whether or not the loan is a discount loan or a traditional loan.

b. higher if the loan is a premium loan.

c. the interest rate plus any fees associated with the loan

d. higher if the interest is paid at maturity.

Difficulty Level: Medium

Subject Heading: Revolving Credit Agreements

L.O. 16.3

97. In general,

a. a revolving credit agreement is more expensive but less risky to the firm than a line of credit.

b. a revolving credit agreement is more expensive and more risky to the firm than a line of credit.

c. a revolving credit agreement is less expensive and less risky to the firm than a line of credit.

d. a revolving credit agreement is less expensive but more risky to the firm than a line of credit.

Difficulty Level: Hard

Subject Heading: Revolving Credit Agreements

L.O. 16.3

98. The Small Business Administration:

a. lends exclusively to small business investment companies that in turn lend to small businesses

b. makes only working capital loans

c. lends to businesses with reasonable prospects of repayment but which cannot obtain credit through private channels

d. makes loans at lower than market rates

Difficulty Level: Easy

Subject Heading: Small Business Administration

L.O. 16.3

99. The Small Business Administration does not assist in the financing of small businesses in which of the following way?

a. limit interest rates charged on a SBA loan

b. participating jointly with banks in extending loans to businesses

c. guaranteeing bank loans to businesses

d. providing receivable financing

Difficulty Level: Easy

Subject Heading: Small Business Administration

L.O. 16.3

100. An organization without a bank charter that advances funds to businesses is called a (n):

a. credit union

b. financial services firm

c. commercial financing company

d. savings and loan

Difficulty Level: Easy

Subject Heading: Commercial Finance Companies

L.O. 16.3

101. A short-term promissory note sold by high-credit-quality corporations and is backed solely by the credit quality of the issuer is called:

a. commercial paper

b. a line of credit

c. a revolving credit agreement

d. a factoring arrangement

Difficulty Level: Easy

Subject Heading: Revolving Credit Agreements

L.O. 16.3

102. Commercial finance companies obtain loanable funds:

a. to a lesser extent than commercial banks through equity capital

b. through both long- and short-term borrowing

c. from the Small Business Administration

d. primarily from the sale of preferred stock

Difficulty Level: Medium

Subject Heading: Commercial Finance Companies

L.O. 16.3

103. The Small Business Administration cannot assist in the financing of small enterprises by:

a. making direct loans to businesses

b. participating jointly with private banks in extending loans to businesses

c. engaging in accounts receivable factoring

d. agreeing to guarantee a bank loan

Difficulty Level: Easy

Subject Heading: Small Business Administration

L.O. 16.3

104. The most frequently cited justification for requiring a compensating balance is:

a. for a commission; to cover the costs of loaning the money

b. to be reassured of some recovery in the event of bankruptcy of the firm

c. to make bank borrowers also be depositors

d. to pay interest for the use of the money

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

LO 16.3

105. A compensating balance on a bank loan effectively ____________ the cost of the loan.

a. raises

b. lowers

c. has no effect on

d. has an indeterminate effect on

Difficulty Level: Medium

Subject Heading: Bank Lines of Credit

LO 16.3

106. The effective annual interest rate on a one-year, $1,000,000, 12% discount loan that requires a 10% compensating balance is

a. 22%.

b. 13.3%.

c. 13.6%.

d. 12.0%.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

107. The effective annual interest rate on a one-year, $1,000,000, 10% discount loan that requires a 10% compensating balance is

a. 11.1%.

b. 13.3%.

c. 20%.

d. 10.0%.

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

108. The effective annual interest rate on a loan in which a company borrows $1,000,000 for one year at 8 percent and requires a compensating balance of 10 percent is:

a. 9.5%

b. 8.5%

c. 8.9%

d. 18%

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

109. The effective annual interest rate on a loan in which a company borrows $1,000,000 for one year at 8 percent and requires a compensating balance of 20 percent is:

a. 8.5%

b. 9.5%

c. 10%

d. 28%

Difficulty Level: Medium

Subject Heading: Computing Interest Rates

L.O. 16.3

110. If a company can stretch its accounts payable without damaging its credit rating, it is effectively ___________ the cost of foregoing the cash discount.

a. increasing

b. reducing

c. not affecting

d. not able to determine.

Difficulty Level: Medium

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

111. If a company can stretch its accounts payable without damaging its credit rating, it is effectively ___________ its operating cycle.

a. increasing

b. reducing

c. not affecting

d. not able to determine.

Difficulty Level: Medium

Subject Heading: Cost of Trade Credit

L.O. 16.4

112. Large U.S. corporations of high credit quality can issue or sell short-term promissory notes called:

a. revolving credit agreements

b. commercial paper

c. trade credit

d. inventory loans

Difficulty Level: Easy

Subject Heading: Commercial Paper

L.O. 16.4

113. Commercial finance companies:

a. make riskier unsecured business loans but charge higher interest rates

b. specialize in loans secured by inventories and real estate

c. concentrate their lending activity to firms pledging the notes receivable of their customers

d. are primarily interested in loans secured by a business customer’s accounts receivable and inventories

Difficulty Level: Easy

Subject Heading: Commercial Finance Companies

L.O. 16.4

114. Which of the following short-term sources of funds is available only to the financially strongest concerns?

a. trade credit

b. commercial bank loans

c. finance company loans

d. commercial paper

Difficulty Level: Easy

Subject Heading: Commercial Paper

L.O. 16.4

115. A commercial finance company:

a. has a bank charter

b. may not discount accounts receivable

c. may make loans secured by chattel mortgages

d. none of the above

Difficulty Level: Easy

Subject Heading: Commercial Finance Companies

L.O. 16.4

116. Which of the following organizations are involved in accounts receivable financing for businesses?

a. consumer finance companies

b. commercial finance companies

c. factors

d. commercial finance companies and factors

Difficulty Level: Easy

Subject Heading: Mixed

L.O. 16.4

117. The most important form of short-term business financing is:

a. a revolving credit agreement

b. accounts-receivable financing

c. inventory loans

d. trade credit

Difficulty Level: Easy

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

118. Commercial paper dealers:

a. lend to small and large businesses on the basis of their receivables outstanding

b. restrict their paper dealings to negotiable certificates of commercial banks

c. distribute to investors the promissory notes of successful businesses

d. distribute to investors the promissory notes of small but rapidly developing businesses

Difficulty Level: Medium

Subject Heading: Commercial Paper Financing

L.O. 16.4

119. Which of the following is a characteristic of commercial paper dealers?

a. provide greater convenience for their clients than bank borrowing but at rates somewhat higher than bank rates

b. set rates at the beginning of the month

c. recall notes that have been placed with investors if rates change dramatically

d. none of the above is a characteristic of commercial paper dealers

Difficulty Level: Medium

Subject Heading: Commercial Paper

L.O. 16.4

120. Which of the following is not an important source of short-term funds to small businesses?

a. commercial banks

b. commercial paper

c. accounts receivable secured loans and/or use of factors

d. the Small Business Administration

Difficulty Level: Medium

Subject Heading: Providers of Short-Term Financing

L.O. 16.4

121. What is the most important overall source of short-term business financing both in the U.S. and worldwide?

a. lines of credit

b. trade credit

c. notes

d. commercial paper

Difficulty Level: Medium

Subject Heading: Trade Credit from Suppliers

L.O. 16.4

122. Which of the following is not a characteristic of a commercial finance company?

a. advances funds to business concerns by discounting accounts receivable

b. makes loans secured by chattel mortgages on machinery

c. finances deferred-payment sales of commercial and industrial equipment

d. holds a bank charter

Difficulty Level: Medium

Subject Heading: Commercial Finance Companies

L.O. 16.4

123. The most important reason for directly issuing or using commercial paper dealers is:

a. the cost of borrowing is generally less than regular bank rates

b. it’s a profitable alternative to the purchase of Treasury bills

c. the avoidance of compensating balances

d. the convenience and profitability

Difficulty Level: Medium

Subject Heading: Commercial Paper Financing

L.O. 16.4

124. Commercial paper issued by large U.S. corporations is backed by:

a. accounts receivable

b. inventories

c. credit quality of the issuer

d. fixed assets

Difficulty Level: Medium

Subject Heading: Commercial Paper Financing

L.O. 16.4

125. The cost of trade credit involving cash discounts as a form of short-term financing is:

a. usually greater than the cost of commercial bank credit

b. the lowest of any form of short-term financing

c. Neither of these is correct

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

126. The purchaser may deduct 2% from the purchase price if payment is made within 10 days; but if not paid within 10 days, the net amount of the purchase is due within 30 days. The sale is made on what terms?

a. 10/30, net/2

b. 2/10, net/30

c. 2/30, net/10

d. 10/2, net/30

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

127. The approximate effective cost (EC) of financing the discount price of trade credit under terms 2/10, net/30 using a 360 day year is:

a. 25%

b. 30.1%

c. 37.2%

d. 42.5%

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

128. Find the annualized cost of a commercial paper issue the has a $1,000,000 face value, matures in 180 days, has a placement fee of 1.5% and an interest charge of 8.5% over the 6 month period it is outstanding.

a. 10%

b. 11.1%

c. 23.5%

d. 24.5%

Difficulty Level: Medium

Subject Heading: Commercial Paper

L.O. 16.4

129. 2/10 net 30 translates as

a. a 2 percent cash discount may be taken if paid in 10 days of shipment; if not paid within 10 days, the net amount is due in 30 days.

b. a 2 percent cash discount may be taken if paid in 10 days of shipment; if not paid within 10 days, the net amount is due 30 days after the middle of the month.

c. a 2 percent cash discount may be taken if paid in 10 days of shipment; if not paid within 10 days, the net amount is due 30 days after the end of the month.

d. a 2 percent cash discount may be taken if paid in 10 days of shipment; if not paid within 15 days, the net amount is due in 20 days.

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

130. If a firm chooses to take a cash discount, it should

a. pay as soon as possible.

b. pay on the last day of the credit period.

c. take the discount no matter when the firm actually pays.

d. pay on the last day of the discount period.

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

131. If a firm chooses to take a cash discount when offered terms of 1/15 net 35, it should

a. pay on the first day of the discount period.

b. pay on day 15.

c. pay on day 35.

d. pay somewhere in the middle of the discount price.

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

132. Eriez Magnetics purchased goods with a purchase price of $10,000 and credit terms of 2/10 net 30. The firm paid for these goods on the 5th day after the date of sale. The firm must pay ________ for the goods.

a. $8,000

b. $9,800

c. $9,000

d. $10,000

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

133. Eriez Magnetics purchased goods with a purchase price of $10,000 and credit terms of 3/10 net 40. The firm paid for these goods on the 5th day after the date of sale. The firm must pay ________ for the goods.

a. $7,000

b. $9,900

c. $9,700

d. $10,000

Difficulty Level: Medium

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

134. Ningbo Steel was extended credit terms of 3/15 net 30. If the firm were able to stretch its accounts payable to 60 days without damaging its credit rating, the cost of giving up the cash discount would only be

a. 18.81%

b. 18.25%

c. 21.90%

d. 25.09%

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

135. Ningbo Steel was extended credit terms of 3/15 net 30. If the firm were able to stretch its accounts payable to 50 days without damaging its credit rating, the cost of giving up the cash discount would only be

a. 56.4%

b. 32.3%

c. 23.90%

d. 22.6%%

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

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

a. 56.4%

b. 62%

c. 74%

d. 75.3%

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

137. Tangshan Mining was extended credit terms of 4/10 net 30. The cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, is closest to

a. 76%

b. 50.7%

c. 75%

d. 73%

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

138. Assume that Ningbo Steel borrows $1,000,000 for one year under a line of credit with a stated interest rate of 7.5 percent and a 15 percent compensating balance and that the firm keeps no money on deposit in its checking account. Based on this information, the effective annual interest rate on the loan is

a. 8.8%.

b. 15.0%.

c. 22.5%.

d. 8.2%.

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

139. Assume that Ningbo Steel borrows $2,000,000 for one year under a line of credit with a stated interest rate of 9.5 percent and a 10 percent compensating balance and that the firm keeps no money on deposit in its checking account. Based on this information, the effective annual interest rate on the loan is

a. 19.5%.

b. 21.1%.

c. 11.1%.

d. 10.6%.

Difficulty Level: Hard

Subject Heading: Nonbank Short-Term Financing Sources

L.O. 16.4

140. A receivable from the sale of merchandise on the basis of a draft or bill of exchange drawn against the buyer or the buyer’s bank is termed a (n):

a. acceptance

b. assignment

c. co-maker loan

d. warehouse loan

Difficulty Level: Medium

Subject Heading: Acceptances

L.O. 16.5

141. Which of the following are not typical of an accounts receivable loan arrangement?

a. basic interest charge

b. compensating balance

c. fee to cover extra work need for such a loan

d. inventory pledging

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

142. An organization that engages in accounts-receivable financing by purchasing the accounts outright is referred to as a:

a. field warehouse firm

b. commercial finance company

c. factor

d. commercial paper house

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

143. The factoring of receivables:

a. typically has the factor becoming the firm’s credit department

b. is especially suited to the heavy durable goods industries

c. has now been largely replaced with other types of financing

d. places special risk on the firm whose receivables are being factored

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

144. Under ___________________ a factor pays the firm for its receivables before the account due date.

a. reverse factoring

b. maturity factoring

c. advance factoring

d. nonrecourse factoring

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

145. A business that needs short-term credit in excess of its regular line of bank credit may:

a. sell common stock to the bank with a repurchase agreement

b. subordinate the interests of the owners to the bank’s additional loans

c. make limited use of overdrafts

d. pledge accounts receivable as specific collateral for an additional loan

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

146. If a firm actually sells its accounts receivable, the process is known as:

a. wholesale financing

b. pledging

c. field crediting

d. factoring

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

147. If life insurance is pledged as collateral for a loan, how much can be borrowed?

a. face value of the policy

b. cash surrender of the policy

c. an amount equal to the annual premium

d. only 50% of the face value of the policy

Difficulty Level: Medium

Subject Heading: Other Forms of Security for Loans

L.O. 16.6

148. The factor, unlike the commercial finance company:

a. engages in accounts receivable financing

b. purchases the accounts receivable outright

c. assumes limited credit risks

d. is not responsible for the collection of accounts

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

149. Which of the following is not a reason to use factoring services?

a. it is a form of guaranteed payment

b. it eliminates overhead

c. management is freed from concern with financial matters

d. lower cost

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

150. Pledging accounts receivable has all of the following characteristics except:

a. money is advanced to the borrower as a loan against accounts receivable

b. accounts receivable balances remain on the balance sheet

c. the customer payment is made to the firm, which then submits the payment to the bank

d. requiring life insurance on the owner(s) of the firm

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

151. Pledging accounts receivable has all of the following characteristics except:

a. money is advanced to the borrower as a loan against accounts receivable

b. accounts receivable balances are removed from the balance sheet

c. the customer payment is made to the firm, which then submits the payment to the bank

d. receivables are collected by the firm

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

152. Factoring accounts receivable has all of the following characteristics except:

a. the borrower sells the receivable

b. accounts receivable balances are removed from the balance sheet

c. the customer payment is made to the factor

d. the firm makes the collection efforts

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

153. Factoring accounts receivable has all of the following characteristics except:

a. money is advanced to the borrower as a loan against accounts receivable

b. accounts receivable balances are removed from the balance sheet

c. the customer payment is made to the factor

d. the borrower sells the receivable

Difficulty Level: Medium

Subject Heading: Accounts Receivable Financing

L.O. 16.5

154. Where a firm obtains a short-term loan by using accounts receivable as collateral.

a. Discounted loan

b. Pledge

c. Factor

d. Secured loan

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

155. A firm that engages in accounts receivable financing by purchasing accounts and assuming all credit risks.

a. Discounted loan

b. Pledge

c. Factor

d. Secured loan

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

156. A firm selling its receivables is paid on the normal collection date, or net due date, of the account.

a. Maturity factoring

b. Regressive factoring

c. Reverse factoring

d. Advance factoring

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

157. Where the factor pays the firm for its receivables before the account due date.

a. Maturity factoring

b. Regressive factoring

c. Reverse factoring

d. Advance factoring

Difficulty Level: Easy

Subject Heading: Accounts Receivable Financing

L.O. 16.5

158. Which of the following is not true regarding pledging accounts receivable?

a. It is a loan against accounts receivable

b. Accounts receivable balances are removed from the balance sheet

c. Customer pays the firm, which submits the payment to the bank

d. There are audit fees for periodic reviews

Difficulty Level: Moderate

Subject Heading: Table 16.2

L.O. 16.5

159. Which of the following is not true regarding factoring accounts receivable?

a. Accounts receivable balances are removed from the balance sheet

b. It is a sale of accounts receivable

c. Factor makes the credit decision

d. There are audit fees for periodic reviews

Difficulty Level: Moderate

Subject Heading: Table 16.2

L.O. 16.5

160. A __________________ is a claim against a customer’s inventory when the individual items are indistinguishable.

a. floor plan receipt

b. trust receipt

c. warehouse receipt

d. blanket inventory lien

Difficulty Level: Easy

Subject Heading: Inventory Loans

L.O. 16.6

161. Firms who wish to obtain short-term secured loans generally have two major current assets available as collateral in the form of:

a. cash and marketable securities

b. receivables and inventory

c. receivables and factoring

d. inventory and floor planning

Difficulty Level: Medium

Subject Heading: Inventory Loans

L.O. 16.6

162. Which would not be likely to be accepted as collateral for an inventory loan?

a. nails at a hardware store

b. cars at an automobile dealership

c. vegetables at a grocery store

d. TV’s at an appliance store

Difficulty Level: Medium

Subject Heading: Inventory Loans

L.O. 16.6

163. Which of the following might is not a characteristic of a field warehouse?

a. it serves multiple customers

b. it exists only until the loan is repaid

c. a lease on that portion of the property which is to be used for warehousing purposes must be obtained

d. it is a secured warehouse

Difficulty Level: Medium

Subject Heading: Inventory Loans

L.O. 16.6