Principles of Managerial Finance, 13e, Global Edition (Gitman) Chapter 16 Current Liabilities Management
16.1 Review accounts payable, payable, the key components of credit terms, and the procedures for analyzing those terms. 1) Accounts payable are spontaneous secured sources of shortterm financing that arise from the normal operations of the firm. Answer! "A#$% &opic! Accounts 'ayable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) $pontaneous unsecured financing has a specific interest cost associated with it that can be at a fi-ed or floating rate. Answer! "A#$% &opic! &o pic! $pontaneous #iabilities (uestion $tatus! ew AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) otes payable can be either spontaneous secured or spontaneous unsecured financing and result from the normal operations of the firm. Answer! "A#$% &opic! &o pic! otes 'ayable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) Accounts payable result from transactions in which merchandise is purchased but no formal note is signed to show the purchasers liability to the seller. Answer! &R2% &opic! Accounts 'ayable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) 4n credit terms, %5 7%ndofonth) indicates that the accounts payable must be paid by the end of the month in which the merchandise has been purchased. Answer! "A#$% &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) $pontaneous liabilities such as accounts payable and accruals represent a source of financing that arise from the normal course of business. Answer! &R2% &opic! &o pic! $pontaneous #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1 opyright 8 91 'earson %ducation
:) $pontaneous liabilities such as accounts payable and notes payable represent a source of financing that arise from the normal course of business. Answer! "A#$% &opic! &o pic! $pontaneous #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) $pontaneous liabilities such as accounts payable and accruals represent a use of financing that arise from the normal course of business. Answer! "A#$% &opic! &o pic! $pontaneous #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) "or firms that are in a financial position to take a cash discount, it is generally a more financially sound decision not to take the discount if the terms offered are =19 net /9. Answer! "A#$% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) +enerally as sales increase a company needs more inventory and more employees resulting in A) more accounts payable and accruals, and therefore increasing its spontaneous financing. *) less accounts payable and accruals, and therefore decreasing its spontaneous financing. ) more accounts payable and accruals, and therefore decreasing its spontaneous financing. >) less accounts payable and accruals, and therefore increasing its spontaneous financing. Answer! A &opic! &o pic! $pontaneous #iabilities (uestion $tatus! ew AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 11) &he two ma?or sources of shortterm financing are A) a line of credit and accounts a ccounts payable. *) accounts payable and accruals. ) a line of credit and accruals. >) accounts receivable and notes payable. Answer! * &opic! &o pic! Accounts 'ayable and Accrued #iabilities #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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1) Accruals and accounts payable are @@@@@@@@ sources of shortterm financing. A) negotiated, secured *) negotiated, unsecured ) spontaneous, secured >) spontaneous, unsecured Answer! > &opic! &o pic! Accounts 'ayable and Accrued #iabilities #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/) @@@@@@@@ are the ma?or source of unsecured shortterm financing for business firms. A) Accounts receivable *) Accruals ) otes payable >) Accounts payable Answer! > &opic! Accounts 'ayable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 10) "inancing that arises from the normal operations of the firm is said to be A) e-pected. *) accrued. ) spontaneous. >) payable. Answer! &opic! &o pic! $pontaneous #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 13) &angshan ining was e-tended credit terms of /=13 net /9 %5. &he cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, would be A) :3.6. *) 1;.36. ) :.<<. >) /:.1. Answer! A &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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16. 2nderstand the effects effects of stretching stretching accounts payable on their cost and the use of accruals. accruals. 1) Accruals are liabilities liabilities for services received for which payment has h as yet to be made. Answer! &R2% &opic! Accrued #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) &he cost of giving up a cash discount is the implied rate of interest paid in order to delay payment of an account payable for an additional number of days. Answer! &R2% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) 4n giving up a cash ca sh discount, the amount of the discount d iscount that is given up is the interest being paid by the firm to keep its money by delaying payment for a number of days. Answer! &R2% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) 4f a firm anticipates stretching accounts payable, its cost of giving up a cash discount is increased. Answer! "A#$% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) A firm should take the cash discount if the firms cost of borrowing from the bank is greater than the cost of giving up a cash discount. Answer! "A#$% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) 4f a firm anticipates stretching accounts payable, its cost of giving up a cash discount is reduced. Answer! &R2% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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:) "or firms that are in a financial position to take a cash discount, it is generally a more financially sound decision to take the discount if the terms offered are =19 net /9. Answer! &R2% &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) 4f possible, it would be a more financially sound soun d decision to pay employees once o nce every two weeks rather than once a month. Answer! "A#$% &opic! &o pic! Accrued #iabilities #iabilities anagement anagement (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) @@@@@@@@ are liabilities for services received for which p ayment has yet to be made. &he most common accounts are ta-es and wages. A) otes payable *) Accruals ) Accounts payable >) Accounts receivable Answer! * &opic! Accrued #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) 1=13 net /9 date of invoice translates as A) a 1 percent cash discount may be taken if paid in 13 daysB if no cash discount is taken, the balance is due in /9 days after the middle of the month. *) a 1 percent cash discount may be taken if paid in 13 daysB if no cash discount is taken, the balance is due /9 days after the invoice date. ) a 1 percent cash discount may be taken if paid in 13 daysB if no cash discount is taken, the balance is due /9 days after the end of the month. >) a 1 percent discount may be taken on 13 percent of the purchase if the account is paid within /9 days after the end of the month. Answer! * &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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11) /=19 net 03 %5 translates as A) a 19 percent cash discount may be taken if paid in three daysB if no cash discount is taken, the balance is due in 03 days. *) a / percent cash discount may be taken if paid in 19 daysB if no cash discount is taken, the balance is due 03 days after transaction is complete. ) a / percent cash discount may be taken if paid in 19 daysB if no cash discount is taken, the balance is due 03 days after the end of the month. >) a / percent discount may be taken on 19 percent of the purchase if the account is paid within 03 days after the end of the month. Answer! &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1) 5ne of the most common designations d esignations for the beginning of the credit period is A) =19. *) the date of invoice. ) the end of the month. >) the transaction date. Answer! * &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/) 4f the firm decides to take the cash discount that is offered on goods purchased on o n credit, the firm should A) pay as soon as possible. *) pay on the last day of the credit period. ) take the discount no matter when the firm actually pays. >) pay on the last day of the discount period. Answer! > &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 10) &he cost of giving up a cash discount on a credit purchase is A) added on to the price of the goods. *) deducted from the price of the goods. ) the implied interest rate paid in order to delay d elay payment for an additional number of days. >) the true purchase price of the goods. Answer! &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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13) Chen a firm stretches accounts payable without hurting its credit rating, the cost of foregoing the cash discount is A) reduced. *) increased. ) unaffected. >) immaterial. Answer! A &opic! &o pic! $tretching Accounts 'ayable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 16) As part of a union negotiation agreement, the 2nited lerical Corkers Corkers 2nion conceded to be paid every two weeks instead of every week. A ma?or firm employing hundreds of clerical workers had a weekly payroll of D1,999,999 and the cost of shortterm funds was 1 percent. &he effect of this concession was to delay clearing time by one on e week. >ue to the concession, the firm A) realized an annual loss of D19,999. *) realized an annual savings of D19,999. ) increased its cash cycle. >) decreased its cash turnover. Answer! * &opic! &o pic! anaging Accrued Accrued #iabilities (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1:) &angshan ining was e-tended credit terms of /=13 net /9 %5. &he cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, is :3.6 percent. 4f the firm were able to stretch its accounts payable to 69 days without damaging its credit rating, the cost of giving up the cash discount would only be A) 1;.;1. *) 1;.3. ) 1.<9. >) 3.9<. Answer! > &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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1;) &angshan ining was e-tended credit terms of /=13 net /9 %5. &he cost of giving up the cash discount, assuming payment would be made on the last day of the credit period, would be @@@@@@@@. 4f the firm were able to stretch its accounts payable to 69 days without damaging its credit rating, the cost of giving up the cash discount would only be @@@@@@@@. A) :.<<B 1;.;1 *) :.<<B 1;.3 ) :3.3B 1.<9 >) :3.6B 3.9< Answer! > &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1<) A firm purchased goods with a purchase price of D1,999 and credit terms of 1=19 net /9. &he firm paid for these goods on the 3th 3 th day after the date of sale. &he firm must pay @@@@@@@@ for the goods. A) D<<9 *) D<99 ) D1,999 >) D1,199 Answer! A &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 9) A firm purchased goods on Eanuary : with a purchase price of D1,999 and credit terms of =19 net /9 %5. &he firm paid for these goods on "ebruary <. &he firm must pay @@@@@@@@ for the goods. A) D1,999 *) D<;9 ) D;99 >) D<99 Answer! * &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1) *y offering credit to customers, the firm may A) increase the price of the good to cover its costs. *) decrease its investment in accounts receivable. ) decrease its investment in accounts payable. >) decrease the cost of goods purchased. pu rchased. Answer! A &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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) 4f a firm gives up the cash discount on goods purchased on credit, the firm should pay the bill A) as late as possible. *) as soon as possible. ) before the credit period ends. >) on the last day of the credit period. Answer! > &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) A firm is offered credit terms of =19 net 03 by most of its suppliers but freFuently does not have the cash available to take the discount. &he firm has a credit line available at a local bank at an interest rate of 1 percent. &he firm should A) give up the cash discount, d iscount, financing the purchase with the line of credit. *) take the cash discount and pay on the 03th day after the date of sale. ) take the cash discount and pay on the first day of the cash discount period. >) take the cash discount, financing the purchase with the line of credit, the cheaper ch eaper source of funds. Answer! > &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 0) A firm is offered credit terms of 1=19 net 03 %5 by a ma?or supplier. &he firm has determined that it can stretch the credit period 7net period only) by 3 days without damaging its credit standing with the supplier. Assuming Assuming the firm needs shortterm financing and can borrow from the bank on a line of credit at an interest rate of 10 percent, the firm should A) give up the cash discount d iscount and finance the purchase with the line of credit. *) give up the cash discount and pay on the :9th day after the date of sale. ) take the cash discount and pay on the first day of the cash discount period. >) take the cash discount and finance the purchase with the line of credit, the cheaper source of funds. Answer! * &opic! Analyzing redit &erms (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 3) &he cost of giving up a cash discount under the terms of sale 1=19 net 69 7assume a /69day year) is A) :./ percent. *) 6.1 percent. ) 10.: percent. >) 1. percent. Answer! A &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills < opyright 8 91 'earson %ducation
6) &he cost of giving up a cash discount under the terms of sale 3=9 net 19 7assume a /69day year) is A) 13 percent. *) 1;.< percent. ) 13.; percent. >) 9 percent. Answer! * &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills :) Ashleys Ashleys >elivery $ervice is analyzing the credit terms of each of three suppliers, A, *, and .
7a) >etermine >etermine the appro-imate appro-imate cost of giving giving up the cash discount. discount. 7b) Assuming the firm needs shortterm financing, recommend recommend whether or not the firm should give up the cash discount or borrow from the bank at 19 percent annual interest. %valuate each supplier separately. separately. Answer! 7a)
%ven though $uppliers * and appear to have different credit terms, the cost of giving up the discount is the same. 7b) &he firm should should borrow from from the bank in all instances. instances. &opic! &o pic! ost of +iving +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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16./ >escribe interest rates and the basic types of unsecured bank sources of shortterm loans. 1) 2nlike the spontaneous sources of unsecured shortterm financing, bank loans are negotiated and result from deliberate actions taken by the financial manager. Answer! &R2% &opic! &o pic! *ank #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) $elfliFuidating loans are intended merely to carry the firm through seasonal peaks in financing needs, mainly buildups of accounts receivable and inventory. Answer! &R2% &opic! &o pic! $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) $elfliFuidating loans are mainly invested in productive assets 7i.e., fi-ed a ssets) which provide the mechanism through which the loan is repaid. Answer! "A#$% &opic! &o pic! $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) &he ma?or attraction of a line of credit from the banks point of view is that it eliminates the need to e-amine the credit worthiness of a customer each time it borrows money. Answer! &R2% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) &he interest rate on a line of credit is normally no rmally stated as a fi-ed ratethe prime rate plus a percent. Answer! "A#$% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) A line of credit is an agreement between a commercial bank and a business specifying the amount of unsecured shortterm borrowing the bank will make available to the firm over a given period of time. Answer! &R2% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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:) A revolving credit agreement is a form of financing consisting of shortterm, unsecured promissory notes issued by firms with with a high credit standing. Answer! "A#$% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) A shortterm selfliFuidating loan is a secured shortterm loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid. Answer! "A#$% &opic! &o pic! $hortterm $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) &he discount rate is the lowest rate of interest charged by the nations leading banks on business loans to their most important important and reliable business borrowers. Answer! "A#$% &opic! &o pic! >iscount Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) 5perating change restrictions are contractual restrictions that a bank may impose on a firm as part of a line of credit agreement. Answer! &R2% &opic! &o pic! 5perating hange Restrictions (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 11) &he effective effective interest rate on a bank ban k loan depends on whether interest is paid when the loan matures or in advance. Answer! &R2% &opic! &o pic! %ffective 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1) &he prime rate of interest fluctuates with changing supplyanddemand relationships for shortterm funds as well as the risk of the banks business borrowers. Answer! "A#$% &opic! &o pic! 'rime 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/) A discount loan is a loan on which interest is paid in advance by deducting it from the loan so that the borrower actually receives less money than is reFuested. Answer! &R2% &opic! &o pic! >iscount #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1 opyright 8 91 'earson %ducation
10) A singlepayment note is a secured fund which can be obtained from a commercial bank when a borrower needs additional funds for a short period. Answer! "A#$% &opic! &o pic! $ingle 'ayment 'ayment otes (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 13) 2nder a line of credit agreement, a bank may retain the right to revoke the line if any ma?or changes occur in the firms financial condition or operations. Answer! &R2% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 16) 2nder a line of credit agreement, a bank may reFuire an annual cleanup, which means that the borrower must pay off all its outstanding debts to all lenders for a certain number of days during the year. Answer! "A#$% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1:) Although Although more e-pensive than a line of credit, a revolving credit agreement can be less risky from the borrowers viewpoint. Answer! &R2% &opic! &o pic! Revolving redit Agreements Agreements versus #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1;) +enerally the increment above the prime rate on a floatingrate loan will be higher than on a fi-edrate loan of eFuivalent risk because the lender bears higher risk with a floatingrate loan. Answer! "A#$% &opic! &o pic! "loating Rate versus "i-edRate #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1<) A fi-edrate loan is a loan whose rate of interest is established at a fi-ed increment above the prime rate and is allowed to vary above prime only when the prime rate varies until maturity. maturity. Answer! "A#$% &opic! &o pic! "i-edRate #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 9) &he effective interest rate for a discount loan is greater than the loans stated interest rate. Answer! &R2% &opic! &o pic! %ffective 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/ opyright 8 91 'earson %ducation
1) A compensating balance, which is a reFuired checking account balance eFual to a certain percentage of the borrowers shortterm unsecured loan, may not only forces the borrower to be a good customer of the bank but may also raise the interest cost to the borrower, thereby increasing the banks earnings. Answer! &R2% &opic! &o pic! ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) 4f possible, it would be a more financially sound decision to pay employees once a month rather than once every two weeks. Answer! &R2% &opic! &o pic! Accrued #iabilities #iabilities anagement anagement (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) 4f one borrows D1,999 at ; percent interest on a discount basis, the effective rate of interest is about ;.: percent. Answer! &R2% &opic! &o pic! >iscount #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 0) 4f one borrows D1,999 at ; percent interest on a discount basis, the effective rate of interest is about <.: percent. Answer! "A#$% &opic! &o pic! >iscount #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 3) #ines of credit are nonguaranteed loans that specify the ma-imum amount that a firm can owe the bank at any point in time. Answer! &R2% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) #ines of credit are guaranteed loans that specify the ma-imum amount that a firm can owe the bank at any point in time. Answer! "A#$% &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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:) &angshan ining borrowed D19,999 for one year under a line of credit with a stated interest rate of ; percent and a 19 percent compensating balance. ormally, ormally, the firm keeps almost no money in its checking account. *ased on this information, the effective annual interest rate on the loan was ;.;< percent. Answer! &R2% &opic! &o pic! #ines of redit redit with ompensating ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills ;) &angshan ining borrowed D19,999 for one year under a line of credit with a stated interest rate of ; percent and a 19 percent compensating balance. ormally, ormally, the firm keeps a balance of about D;99 in its checking account. *ased on this information, the effective annual interest rate on the loan was ;.;< percent. Answer! "A#$% &opic! &o pic! #ines of redit redit with ompensating ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills <) Revolving credit agreements are guaranteed loans that specify the ma-imum amount that a firm can owe the bank at a t any point in time. Answer! &R2% &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /9) Revolving credit agreements are nonguaranteed loans that specify the ma-imum amount that a firm can owe the bank at any point in time. Answer! "A#$% &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /1) &angshan ining borrowed D19,999 for one year under a revolving credit agreement that authorized and guaranteed the firm access to D9,999. &he revolving credit agreement had a stated interest rate of ; percent and charged the firm a half percent commitment fee on the unused portion of the agreement. *ased on this information, the effective annual interest rate on the loan was ;.39 percent. Answer! &R2% &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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/) &angshan ining borrowed D19,999 for one year under a revolving credit agreement that authorized and guaranteed the firm access to D9,999. &he revolving credit agreement had a stated interest rate of ; percent and charged the firm a half percent commitment fee on the unused portion of the agreement. *ased on this information, the effective annual interest rate on the loan was <.39 percent. Answer! "A#$% &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills //) ull 4ncorporated recently borrowed D39,999 from entury *ank when the prime rate was 0. &he loan was for <9 days with interest to be paid at the end of the period with a rate fi-ed at 1.3 above the prime rate. Chat is the total interest paid on this loan and what is the effective annual rateG 7Assume a /63 day year.) year.) A) &he total interest paid is D//<9.01 and the effective annual rate is 3.6. *) &he total interest paid is D1/,:39 and the effective annual rate is 3.6. ) &he total interest paid is D1/,:39 and the effective annual rate is 3.33. >) &he total interest paid is D//<9.01 and the effective annual rate is 1./6. Answer! A &opic! &o pic! %ffective 4nterest 4nterest Rate Rate (uestion $tatus! ew AA$* +uidelines! +uidelines! Analytic skills /0) &he ma?or type of loan made by banks to businesses is the A) fi-edassetbased loan. *) shortterm secured loan. ) shortterm selfliFuidating loan. >) capital improvement loan. Answer! &opic! &o pic! $hortterm $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /3) $hortterm loans that businesses obtain from banks and through commercial paper are A) negotiated and secured. *) negotiated and unsecured. ) spontaneous and secured. >) spontaneous and unsecured. Answer! * &opic! &o pic! 2nsecured $hortterm $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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/6) $hortterm selfliFuidating loans are intended to A) finance capital assets. *) cover seasonal peaks in financing caused by inventory and receivable buildups. ) finance merger=acFuisition activity. >) recapitalize the firm. Answer! * &opic! &o pic! $hortterm $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /:) A @@@@@@@@ is a type of loan made to a business by a commercial bank. &his type of loan is made when the borrower needs additional funds for a short period but does not believe the need will continue or reoccur on a seasonal basis. A) revolving credit agreement *) line of credit ) shortterm selfliFuidating loan >) single payment note Answer! > &opic! &o pic! $ingle 'ayment 'ayment otes (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /;) &he @@@@@@@@ is the lowest rate of interest charged on business loans to the best business borrowers by the nations leading banks. A) prime rate *) commercial paper rate ) federal funds rate >) treasury bill rate Answer! A &opic! &o pic! 'rime 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /<) $hortterm selfliFuidating loans are intended to A) finance capital assets. *) cover seasonal peaks in financing caused by inventory and receivables buildup. ) finance merger and=or acFuisition activity. >) recapitalize the firm. Answer! * &opic! &o pic! $hortterm $elfliFuidating #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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09) ommercial banks lend unsecured shortterm funds in the following three basic ways. A) $inglepayment note, lines of credit, and commercial paper. *) $inglepayment note, lines of credit, and revolving credit agreements. ) $inglepayment note, revolving credit agreements, and commercial paper. >) ommercial paper, lines of credit, and revolving credit agreements. Answer! * &opic! &o pic! &y &ypes pes of 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 01) 4n a line credit arrangement, the firm pays interest on A) the full line of credit. *) the unused portion of the line of credit. ) only the amount actually borrowed. >) only the amount actually borrowed and commitment fees on any unused portion of the loan. Answer! &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) #oans on which the interest is paid in advance are often called A) premium loans. *) reducedprinciple loans. ) called loans. >) discount loans. Answer! > &opic! &o pic! >iscount #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0/) &he prime rate of interest fluctuates with A) the changing supply and demand relationship for longterm funds. *) the changing supply and demand relationship for shortterm funds. ) the risk of the firm borrowing the funds. >) demand in the bond market. Answer! * &opic! &o pic! 'rime 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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00) A @@@@@@@@ is an agreement between a commercial bank and an d a business that states the ma-imum amount of unsecured shortterm borrowing the bank will make available to the firm over a given period of time, provided sufficient funds are available. A) revolving credit agreement *) line of credit ) shortterm selfliFuidating loan >) single payment note Answer! * &opic! &o pic! #ines of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 03) $easonal buildups of inventory and receivables are generally financed with A) shortterm loans. *) longterm loans. ) accruals. >) stockholders eFuity. Answer! A &opic! &o pic! $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 06) &he effective interest rate generally is A) higher on a loan if interest is paid at maturity. *) lower if the loan is a discount loan. ) higher if the loan is a discount loan. >) not affected by whether the loan is a discount loan or a loan with interest paid at maturity. maturity. Answer! &opic! &o pic! %ffective 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0:) A bank lends a firm D1,999,999 for one year at 1 percent on a discounted basis and reFuires compensating balances of 19 percent of the face value of the loan. &he effective annual interest rate associated with this loan is A) 1 percent. *) 1/./ percent. ) 1/.6 percent. >) 13.0 percent. Answer! > &opic! &o pic! %ffective 4nterest 4nterest Rate Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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0;) @@@@@@@@ effectively raises the interest cost to the borrower on a line of credit. A) An operating change restriction *) An annual cleanup ) A compensating balance >) A commitment fee Answer! &opic! &o pic! ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0<) A bank lends a firm D399,999 for one year at ; percent p ercent and reFuires compensating balances of 19 percent of the face value of the loan. &he effective annual interest rate associated with this loan is A) ;.< percent. *) ; percent. ) :. percent. >) :.9 percent. Answer! A &opic! &o pic! ompensating *alances and %ffective %ffective 4nterest Rates (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 39) @@@@@@@@ ensure that money lent under a line of credit agreement is actually being used to finance seasonal needs. A) 5perating change restrictions *) Annual cleanups ) ompensating balances >) ommitment fees Answer! * &opic! Annual leanups (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 31) A @@@@@@@@ guarantees the borrower bo rrower that a specified amount of funds will be available av ailable regardless of the tightness of money. A) revolving credit agreement *) line of credit ) shortterm selfliFuidating loan >) single payment note Answer! A &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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3) ompared to a line of credit, a revolving credit agreement generally will be A) a lower cost, higher risk method of shortterm borrowing. *) a lower cost, lower risk method of shortterm borrowing. ) a higher cost, higher risk method of o f shortterm borrowing. >) a higher cost, lower risk method of shortterm borrowing. Answer! > &opic! &o pic! #ines of redit versus Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3/) 4n a revolving credit agreement, the firm pays interest on A) the full line of credit. *) the unused portion of the line of credit. ) only the amount actually borrowed. >) the amount actually borrowed and commitment fees on any unused portion po rtion of the loan. Answer! > &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 30) Cith Cith a floatingrate note, the interest rate on the note changes A) when the risk level of the borrower changes. *) when the prime rate changes. ) when the demand for loans changes. >) when bank profits change. Answer! * &opic! &o pic! "loating Rate otes otes (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 33) A firm arranges a discount loan at a 1 percent interest rate, and borrows D199,999 D199,99 9 for one year. &he stated stated interest rate is @@@@@@@@ and the effective interest rate is @@@@@@@@. A) 1.99B 1.99 *) 1/.60B 1.99 ) 1.99B 1/.60 >) 1.99B 19.:1 Answer! &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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36) HIJ orporation borrowed D199,999 for si- months from the bank. &he rate is prime plus percent. &he prime rate was ;.3 percent at the beginning of the loan and changed to < percent after two months. &his was the only change. Kow much interest must HIJ corporation payG A) D,0:6 *) D3,01: ) D1;,1 >) D1,399 Answer! * &opic! &o pic! omputing #oan #oan 4nterest (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 3:) A firm has a line of credit and borrows D3,999 at < percent interest for 1;9 days or half a year. Chat Chat is the effective rate of interest on this loan if the interest is paid in advanceG A) 0.: percent *) <.0 percent ) <.< percent >) 19./ percent Answer! * &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 3;) A firm arranged for a 19day bank loan at an annual rate of interest of 19 percent. 4f the loan is for D199,999, how much interest in dollars will the firm payG 7Assume a /69day year.) A) D19,999 *) D/9,999 ) D/,/// >) D1,999 Answer! &opic! &o pic! omputing #oan #oan 4nterest (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 3<) &angshan &angshan ining borrowed D199,999 for one year under a line of credit with a stated interest rate of :.3 percent and a 13 percent compensating balance. ormally, ormally, the firm keeps almost no money in its checking account. *ased on this information, the effective annual interest rate on the loan is A) :.3. *) ;.9. ) ;.;. >) :.. Answer! &opic! &o pic! #ines of redit redit with ompensating ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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69) &angshan &angshan ining borrowed D199,999 for one year under a line of credit with a stated interest rate of :.3 percent and a 13 percent compensating balance. ormally, ormally, the firm keeps a balance of about D19,999 in its checking account. *ased on this information, the effective annual interest rate on the loan was A) :.;<. *) ;.93. ) ;.;<. >) :.<. Answer! A &opic! &o pic! #ines of redit redit with ompensating ompensating *alances (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 61) Revolving credit agreements are A) guaranteed loans that specify the ma-imum amount that a firm can owe the bank at any point in time. *) nonguaranteed loans that specify the ma-imum amount that a firm can owe the bank at any one time. ) credit arrangements made in cooperation with suppliers that allows the firms to roll over accounts payable each month. >) none of the above. Answer! A &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) &angshan &angshan ining borrowed D199,999 for one year under a revolving credit agreement that authorized and guaranteed the firm access to D99,999. &he revolving credit agreement had a stated interest rate of :.3 percent and charged cha rged the firm a 1 percent commitment fee on the unused portion of the agreement. *ased on this information, the effective effective annual interest rate on the loan was A) :.3. *) ;.9. ) ;.3. >) <.9. Answer! &opic! &o pic! Revolving redit Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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6/) Kayleys &heatrical $upply is in the process of negotiating a line of credit with two local banks. &he prime rate is currently ; percent. &he terms terms follow!
7a) alculate alculate the effective effective interest interest rate of both both banks. 7b) Recommend which banks line of credit Kayleys Kayleys &heatrical $upply should accept. Answer! 9.9; + 9.91
7a) 1st ational ational *ank *ank effective effective cost cost nd ational *ank effective cost
1 9.9 9.9; + 9.9 1 9.13
L 9..113 L 9.11:6
7b) Kayleys would choose the 1st ational ational *ank since it has the the lowest effective effective interest rate 711.3 percent). &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 60) +lobal #ogistics purchased a new machine on 5ctober 9th, 99/ for D1,999,999 on credit. &he supplier has offered AMA terms of =19, net 03. &he current interest rate the bank b ank is offering is 16 percent. 7a) ompute ompute the cost of of giving giving up cash discount. discount. 7b) $hould the firm firm take or give give up the cash discountG discountG 7c) Chat is the effective effective rate of interest interest if the firm decides to take the cash discount discount by borrowing money on a discount basisG Answer! 7a) ost of foregoing foregoing cash cash discount discount
9.9 1 9.9
N
/69 /3
L 1
7b) $ince the cost of foregoing cash discount is greater than the the banks interest rate, the firm should take cash discount. 7c) 4nterest 4nterest L 1,999,999 1,999,999 N 9.16 N 7/3=/69) 7/3=/69) L D13,333.36 D13,333.36 %ffective rate L
13,333.36 1,999,999 13,333.36
N
/69 /3
L 16.3
&opic! ost of +iving &opic! +iving up a ash ash >iscount (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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16.0 >iscuss the basic features of commercial paper and the the key aspects of international short term loans. 1) ommercial paper is a form of financing that consists of shortterm, secured promissory notes issued by firms with a high credit standing. Answer! "A#$% &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) 4n doing business in foreign countries, financing operations in the local market not only improves the companys business ties to the host community but also minimizes e-change rate risk. Answer! &R2% &opic! &o pic! 4nternational #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) &he interest paid by the issuer of commercial paper is determined by the size of the discount and the length of time to maturity. Answer! &R2% &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) &he risk to a 2.$. importer with foreigncurrencydenominated accounts pa yable is that the dollar will depreciate. Answer! &R2% &opic! &o pic! 4nternational #oans and %-change Rate Risk (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) "or firms that are able to raise funds through the sale of commercial, it is generally cheaper than if the same firm were to borrow from a commercial bank. Answer! &R2% &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) &angshan &angshan ining issued D19,999 of commercial co mmercial paper for D<,<3 for 69 days. *ased on this information, the effective annual rate of interest on the commercial pap er would be about 0.6< percent. Answer! &R2% &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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:) &angshan &angshan ining issued D19,999 of commercial co mmercial paper for D<,<3 for 69 days. *ased on this information, the effective annual rate of interest on the commercial pap er would be about 0.1< percent. Answer! "A#$% &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills ;) @@@@@@@@ is a shortterm, unsecured promissory note issued by b y firms with a high credit standing. &hese notes are primarily issued by commercial finance companies. A) A line line of credit *) ommercial paper ) A revolving line of credit >) A selfliFuidating loan Answer! * &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) ost commercial paper has maturities ranging from A) si- months to one year. *) one year to three years. ) three days to :9 da days. ys. >) seven days to /9 days. Answer! &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) ommercial paper is generally issued in multiples of A) D1,999 or more. *) D19,999 or more. ) D199,999 or more. >) D1,999,999 or more. Answer! &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 11) uch of the commercial paper is issued by A) commercial finance companies. *) small businesses. ) venture capitalists. >) small manufacturing firms. Answer! A &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6 opyright 8 91 'earson %ducation
1) ost commercial paper is purchased by A) manufacturers. *) governments and individuals. ) banks and life insurers. >) the federal government. Answer! &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/) ommercial paper is usually sold at a discount from A) its cost. *) its par value. ) the prime rate. >) treasury notes. Answer! * &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 10) A letter written by a companys bank to the companys foreign supplier, stating that the bank will guarantee payment of an invoiced amount if all the underlying agreements are met is called A) a letter of invoice. *) a letter of intent. ) a letter of credit. >) none of the above. Answer! &opic! &o pic! #etters of redit (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 13) &he cost of borrowing through the sale of commercial paper is typically @@@@@@@@ the prime bank loan rate. A) lower than *) the same as ) unrelated to >) higher than Answer! A &opic! &o pic! ommercial 'aper versus *ank #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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16) A firm issued D million worth of commercial paper that has a <9day < 9day maturity and sells for D1,<99,999. &he annual interest rate on the issue of commercial paper is A) 3 percent. *) 19 percent. ) 1: percent. >) 1 percent. Answer! > &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1:) A firm has directly placed an issue of commercial paper that has a maturity of 69 days. &he issue sold for D<;9,999 and has an annual interest rate of 1.0 percent. &he value of the commercial paper at maturity is A) D1<,<<. *) D<;9,999. ) D<<<,<<. >) D<69,99;. Answer! &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1;) &angshan ining issued D1,999,999 of commercial paper for D<<,399 for 03 days. *ased on this information, the effective annual rate of interest on the commercial paper would be A) 6.1/. *) 6.<. ) 6.0. >) 6.9;. Answer! * &opic! &o pic! ommercial 'aper (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 1<) *essey Aviation Aviation has ?ust sold an issue of /9day commercial paper with a face value of D3,999,999. &he firm has ?ust received D0,<3;,999. D0,<3 ;,999. Chat is the effective annual interest rate on the commercial paperG Answer! O7D3,999,999 D0,<3;,999)=D0,<3;,999P N 1 L 9.191: &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills
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9) &inas Apple ompany would like to manufacture and market a new packaging. &inas has sold an issue of commercial paper for D1,399,999 and maturity of <9 days to finance the new pro?ect. ompute the annual interest rate on the issue of commercial paper if the value of the commercial paper at maturity is D1,639,999. Answer! 4nterest paid paid L D1,639,999 1,399,999 L D139,999 Annual interest rate L 7D139,999=D1,399,999) 7/69=<9) L 09 &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Analytic skills 16.3 %-plain the characteristics of secured shortterm shortterm loans and the use use of accounts receivable as shorttermloan collateral. 1) $ecured shortterm financing has specific assets pledged as collateral and appears on the balance sheet as current liabilities. Answer! &R2% &opic! &o pic! $ecured $hortterm "inancing (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) &he outright sale of accounts receivable at a discount in order to obtain funds is called pledging accounts receivable. Answer! "A#$% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) 5ne advantage of factoring accounts receivable is the ability it gives the firm to turn accounts receivable immediately into cash without having to worry wo rry about repayment. Answer! &R2% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) "i-ed assets are the most desirable shortterm loan collateral since they no rmally have a longer life, or duration, than the term of the loan. Answer! "A#$% &opic! &o pic! &he 2se of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) +enerally, lenders recognize that holding collateral can reduce losses if the borrower defaults, but the presence of collateral has no impact on the risk of default. Answer! &R2% &opic! &o pic! &he 2se of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills < opyright 8 91 'earson %ducation
6) &he interest rate charged on secured shortterm loans is typically higher than the rate on unsecured shortterm loans. Answer! &R2% &opic! &o pic! $ecured versus 2nsecured 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills :) &he higher cost of unsecured as opposed o pposed to secured borrowing is due to the greater risk of default. Answer! "A#$% &opic! &o pic! $ecured versus 2nsecured 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) ommercial finance companies are lending institutions that make o nly unsecured loansboth shortterm and longterm to businesses. Answer! "A#$% &opic! &o pic! ommercial "inance ompanies (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
<) ommercial finance companies usually charge a higher interest on secured shortterm loans than commercial banks because the finance companies generally end up with higherrisk borrowers. Answer! &R2% &opic! &o pic! ommercial "inance ompanies (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) "actoring accounts receivable is not a form of secured shortterm borrowing. 4t entails the sale of accounts receivable at a discount to obtain needed shortterm funds. Answer! &R2% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 11) 'ledges of accounts receivable are normally made on a nonnotification basis, meaning that a customer whose account has been pledged as collateral in not notified. Answer! &R2% &opic! &o pic! 'ledging Accounts Receivable (uestion $tatus! ew AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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1) 'ledges of accounts receivable are normally made on a notification basis because the lender does not trust the borrower to collect the pledged account receivable and remit these payments as they are received. Answer! "A#$% &opic! &o pic! 'ledging Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1/) onrecourse basis is the basis on which accounts acco unts receivable are sold to a factor with the understanding that the factor accepts all credit risks on the purchased accounts. Answer! &R2% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 10) &he percentage advance constitutes c onstitutes the principal of the secured loan and varies not only according to the type and liFuidity of collateral but also according to the type of security interest being taken. Answer! &R2% &opic! &o pic! $ecured $hortterm "inancing (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 13) ommercial banks and other institutions do not normally n ormally consider secured loans less risky than unsecured loans, and therefore reFuire higher interest rates on them. Answer! &R2% &opic! &o pic! $ecured versus 2nsecured 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 16) 4n pledging accounts receivable, the percentage advanced against the ad?usted collateral is determined by the borrower based on its overall evaluation of the Fuality of the acceptable receivables and the e-pected cost of their liFuidation. Answer! "A#$% &opic! &o pic! 'ledging Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1:) "actoring accounts receivable is a relatively ine-pensive source of unsecured shortterm funds. Answer! "A#$% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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1;) "actoring accounts receivable is a relatively e-pensive source of unsecured shortterm funds. Answer! "A#$% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1<) "actoring accounts receivable is a relatively ine-pensive source of unsecured shortterm funds that allows firms to turn accounts receivable immediately into cash. Answer! "A#$% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 9) "actoring accounts receivable is a relatively e-pensive source of secured shortterm funds that allows firms to turn accounts receivable immediately into cash. Answer! &R2% &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 1) ollateral is typically reFuired for a A) secured shortterm loan. *) line of credit. ) shortterm selfliFuidating loan. >) single payment note. Answer! A &opic! &o pic! $ecured $hortterm "inancing (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) "inancing that matures in one year or less and has specific assets pledged as collateral is called A) spontaneous financing. *) unsecured shortterm financing. ) secured shortterm financing. >) none of the above. Answer! &opic! &o pic! $ecured $hortterm "inancing (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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/) @@@@@@@@ involves the sale of accounts receivable. A) A trust receipt loan *) "actoring ) A field field warehouse arrangement >) 'ledging of accounts receivable Answer! * &opic! &o pic! Accounts Receivable "actoring (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) All of the following goods represent appropriate collateral for a secured loan to a school supply manufacturer %H%'& A) reams or rolls of paper. *) unbound pages. ) notebooks and binders. >) inde- cards. Answer! * &opic! &o pic! Appropriate "orms "orms of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) All of the following goods represent appropriate collateral for a secured loan to a candy manufacturer %H%'& A) bo-es. *) cocoa beans. ) individually wrapped chocolates. >) cream. Answer! > &opic! &o pic! Appropriate "orms "orms of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) Appropriate collateral for a secured shortterm loan is A) fi-ed assets. *) raw materials inventory and receivables. ) common stock in a privatelyheld corporation. >) workinprocess inventory. Answer! * &opic! &o pic! Appropriate "orms "orms of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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:) #enders reFuire collateral to A) reduce the risk of default. *) control the borrowing firm. ) reduce the losses if the borrower defaults. >) e-tend to the borrower an unsecured loan. Answer! &opic! &o pic! 2se of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) &he interest rate charged on a secured shortterm loan to a corporation is typically @@@@@@@@ the interest rate on an unsecured loan. A) lower than *) the same as ) unrelated to >) higher than Answer! > &opic! &o pic! $ecured versus 2nsecured 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) &he interest rate charged on secured shortterm loans to a corporation is generally higher than that charged on unsecured shortterm loans because A) secured loans are less risky than unsecured loans. *) the risk of default is lower on secured loans. ) it is costly to negotiate and administer secured loans. >) lenders of secured loans must pay more for their funds. Answer! &opic! &o pic! $ecured versus 2nsecured 2nsecured $hortterm #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /9) &he primary source of secured shortterm loans to businesses are A) commercial banks and commercial finance companies. *) savings and loans and factors. ) commercial paper dealers and investment bankers. >) life insurance companies and government securities brokers. Answer! A &opic! &o pic! $ecured $hortterm "inancing (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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/1) 'ledges of accounts receivable and factoring of accounts receivable are made on @@@@@@@@ basis, respectively. respectively. A) a nonrecourse and a notification *) a nonnotification and a notification ) a notification and a recourse >) a notification and a nonrecourse Answer! * &opic! &o pic! 'ledging Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) Chich of the following is 5& an advantage of factoringG A) Accounts receivable immediately turned into cash. *) %limination of credit and collection department. ) reation of a known pattern of cash flows. >) &he effective interest rate. Answer! > &opic! &o pic! "actoring Accounts Receivable (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills //) #enders recognize that by having an interest in collateral they can reduce losses if the borrowing firm defaults, A) and the presence of collateral reduces the risk of default. *) but the presence of collateral has no impact on the risk of default. ) therefore lenders prefer to lend to customers from whom they are able to reFuire collateral. >) therefore lenders will impose a higher interest rate on unsecured shortterm borrowing. Answer! * &opic! &o pic! 2se of ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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/0) Aunt &illys &illys "eeds, 4nc. is considering obtaining funding through advances against receivables. &otal &otal annual credit sales are D699,999, terms are net /9 days, and payment is made on the average of /9 days. Cestern ational *ank will advance funds under a pledging arrangement for 1/ percent annual interest. 5n average, :3 percent of credit sales will be accepted as collateral. ommodity "inance offers factoring on a nonrecourse basis for a 1 percent factoring commission, charging 1.3 percent per month on advances and reFuiring a 13 percent factors reserve. 2nder this plan, the firm would factor all accounts and close its its credit and collections department, saving D19,999 per year. 7a) Chat is the effective effective interest rate rate and the average amount of funds available under pledging pledging and under factoringG 7b) Chich plan do you recommendG recommendG ChyG ChyG Answer! 7a) Cestern Cestern ational ational *ank *ank 7pledging) 7pledging) D699,999 1
79.:3) L D/:,399 funds available
ommodity "inance 7factoring) Avera Average ge acco account untss rece receiva ivable ble 7D699, 7D699,999= 999=1) 1) D39,999 D39,999 #ess! Reserve 713) :,399 #ess! "actoring ommission 39 9 "unds available for advance D0,999 #ess! #ess! 4ntere 4nterest st on advance advance 71.3 71.3 N D0,999) D0,999) 6/9 'roceeds from advance D01,/:9 Cestern Cestern ational effective interest rate L 1/ ommodity "inance effective interest rate L
D6/9 D01,/:9
71) L 1;.:
7b) Cestern ational Annual interest cost L /:,399 N 9.1/ L D0,;:3 ommodity "inance Annu Annual al inte intere rest st cost cost D :,3 :,369 69 7 L 6/9 6/9 7 1) 1) "act "actor ors s comm commis issi sion on 6,99 6,999 9 7 L 399 399 7 1) 1) &otal ost D1/,369 benefit of closing credit department 19,999 et ost D /,369 $ince the net cost of factoring receivables is less e-pensive than pledging receivables and also provides more available funds, Aunt &illys &illys "eeds, 4nc. should choose ommodity "inance. &opic! &o pic! omputing the %ffective %ffective 4nterest Rate (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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16.6 >escribe the various ways in which inventory inventory can be used as shorttermloan collateral. collateral. 1) A floating inventory lien is a lenders claim on the borrowers general inventory as collateral for a secured loan. Answer! &R2% &opic! &o pic! "loating 4nventory #iens (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ) A trust receipt inventory loan is an arrangement in which wh ich the lender receives control of the pledged inventory collateral, which is warehoused by a designated agent. Answer! "A#$% &opic! &o pic! &rust Receipt 4nventory #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills /) &he security agreement is the security offered the lender by the borrower, usually in the form of an asset such as accounts receivable or inventory. Answer! "A#$% &opic! &o pic! $ecurity Agreements (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 0) 4nventory is attractive as collateral since it normally has a market value greater than its book value, which is used to establish its value as collateral. Answer! "A#$% &opic! &o pic! 4nventory as ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 3) A floating inventory lien is most attractive when the firm has a stable level of inventory that consists of a diversified group of relatively ine-pensive merchandise. Answer! &R2% &opic! &o pic! "loating 4nventory #iens (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 6) 2nder the floating inventory lien, the borrower b orrower is free to sell the merchandise and is e-pected e-pec ted to remit the amount lent against each item, along with accrued interest, to the lender immediately after the sale. &he lender then releases the lien on the appropriate item. Answer! "A#$% &opic! &o pic! "loating 4nventory #iens (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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:) Appropriate Appropriate collateral for a loan secured under a floating inventory lien is A) cars. *) drill presses. ) file cabinets. >) paper clips. Answer! > &opic! &o pic! "loating 4nventory #iens (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills ;) Appropriate Appropriate collateral for a loan secured under a trust receipt inventory loan is A) drill bits. *) pencils. ) recreation vehicles. >) bananas. Answer! &opic! &o pic! &rust Receipt 4nventory #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills <) A terminal terminal warehouse is A) a warehouse located at the airport. *) a warehouse on the borrowers premises. ) a central warehouse storing the merchandise of several businesses. >) a warehouse located near the lender. Answer! &opic! Carehous Carehousee Receipt Receip t #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills 19) A field warehouse is A) a warehouse outside the metropolitan area. *) a warehouse on the borrowers premises. ) a central warehouse storing the merchandise of several businesses. >) a warehouse located near the lender. Answer! * &opic! Carehous Carehousee Receipt Receip t #oans (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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11) >iscuss and contrast the three types of loans discussed in the te-t that use inventory as collateral! floating inventory liens, trust receipt inventory loans, and warehouse receipt loans. Answer! &he blanket lien is certainly the easiest for the firm firm since the lender ?ust takes a lien against the firms entire inventory and the borrower typically does n ot have to give the lender precise lists of what constitutes constitutes inventory on a regular basis. &rust &rust receipt financing reFuires the borrower and lender to specify the e-act inventory that backs up each advance. &his can be a timeconsuming and cumbersome type of financing for the firm. "ield warehouse financing reFuires an independent company supervise the collateral for the lender. &his, too, can be a cumbersome type of financing. &opic! &o pic! &he 2se of 4nventory as ollateral ollateral (uestion $tatus! Revised AA$* +uidelines! +uidelines! Reflective thinking thinking skills skills
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