Question 1

Interest rates charged on loans vary depending on the risk of borrower,and the size of the loan,but not the economic conditions.

Accepted Answer

Interest rates charged on loans can be influenced by economic conditions such as inflation, monetary policy, and market demand. In times of economic slowdown or recession, interest rates on loans may be lowered to encourage borrowing and stimulate economic growth. Additionally, the risk of borrower and the size of the loan are not the only factors considered when determining the interest rate. Other factors may include credit score, income level, and loan purpose.

Question 2

The cash budget and the capital budget are handled separately and,although they are both important,they are developed independently of one another.

Accepted Answer

The cash budget and capital budget are interconnected; the capital budget impacts cash flows, which are reflected in the cash budget.

Question 3

Accruals are spontaneous,but,unfortunately,due to law and economic forces,firms have little control over the level of these accounts.

Accepted Answer

Accruals are a result of accounting rules and economic transactions, such as revenue earned but not yet received or expenses incurred but not yet paid. Firms can't control the occurrence of these transactions, and therefore have limited control over the level of their accruals.

Question 4

A firm that follows an aggressive working capital financing approach is more exposed to unexpected changes in the term structure of interest rates than is a firm that follows a conservative financing policy.

Accepted Answer

An aggressive working capital financing approach typically involves borrowing short-term funds to finance current assets, leading to a higher proportion of variable-rate debt in the firm's capital structure. This makes the firm more sensitive to unexpected changes in interest rates, which can potentially create difficulties in servicing their debt obligations. In contrast, a conservative financing policy involves relying more on stable, long-term sources of financing, which can provide greater protection against interest rate fluctuations.

Question 5

While the maturity of most bank loans is short term,they are frequently repaid on demand rather than on a specific maturity date.

Accepted Answer

This statement is true. Bank loans typically have a short-term maturity, but they often include a provision that allows the lender to demand repayment at any time, rather than waiting until a specified maturity date. This is known as a demand loan.

Question 6

Under a revolving credit agreement,the risk to the firm of being unable to obtain funds when needed is lower than with an informal line of credit.

Accepted Answer

This is because a revolving credit agreement provides a predetermined credit limit that the firm can draw upon as needed, whereas an informal line of credit depends on the lender's willingness to lend and may not always be available when needed.

Question 7

Generally,the longer the normal inventory holding period of customers,the longer the credit period.One effect of lengthening the credit period to match the customer's merchandise holding period is to increase the payables deferral period,which shortens the customer's cash conversion cycle.

Accepted Answer

When the credit period is lengthened to match the customer's merchandise holding period, the payables deferral period increases. This, in turn, shortens the customer's cash conversion cycle, as more time is provided for the customer to sell the merchandise and generate cash before having to pay for it. Therefore, the statement is true.

Question 8

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower subject to certain conditions,including the borrower's maintaining its financial strength.

Accepted Answer

A line of credit is a formal agreement between a borrower and a bank where the borrower can access funds up to a certain limit, based on specific terms and conditions. The borrower is expected to maintain their financial strength to continue accessing credit.

Question 9

Under a public warehouse agreement,the inventory used as collateral for the loan is stored on the premises of a third party.

Accepted Answer

A public warehouse agreement involves storing the inventory used as collateral for the loan on the premises of a third party, such as a public storage facility.

Question 10

Due to the complexity of factoring procedures,factoring is rarely used as a source of short-term financing in Canada today.

Accepted Answer

Factoring is actually a commonly used method of short-term financing in Canada and many other countries, as it allows businesses to quickly convert their accounts receivable into cash, thereby improving their liquidity and cash flow.

Question 11

The relative profitability of a firm that employs an aggressive working capital financing policy will improve when the yield curve changes from upward sloping to downward sloping.

Accepted Answer

The yield curve does not directly affect the relative profitability of a firm that employs an aggressive working capital financing policy. The profitability of such a firm depends on the cost of financing and the returns generated from their investments. The shape of the yield curve may indirectly affect the cost of financing, but it is not the only factor that determines profitability.

Question 12

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e.,after the fact) sense even though it is possible to match maturities on an expected basis.

Accepted Answer

This statement is true because there is always some uncertainty about the exact lives of assets, such as unexpected events that could impact their maturity or life span. As a result, it is not always possible to precisely match maturities in an ex post sense, meaning after the fact. However, it is still possible to match maturities on an expected basis, using assumptions and estimates of the asset's likely lifespan.

Question 13

The effect of compensating balances is to decrease the effective interest rate of a loan.

Accepted Answer

Compensating balances increase the effective interest rate of a loan because they require the borrower to maintain a minimum balance in a non-interest-bearing account, effectively reducing the amount of the loan available for use while still paying interest on the full loan amount.

Question 14

The maturity matching,or "self-liquidating," approach involves the financing of permanent net operating working capital with combinations of long-term capital and short-term capital that vary depending on the level of interest rates.When short-term rates are relatively high,short-term assets will be financed with long-term debt to reduce costs and risk.

Accepted Answer

The maturity matching or "self-liquidating" approach involves financing assets with a similar maturity. Permanent net operating working capital would typically be financed with long-term capital, not a combination that varies with interest rates. The approach described mixes strategies and misinterprets the concept of maturity matching.

Question 15

The inventory conversion period of the operating cycle terminates when the inventory is paid for with cash.

Accepted Answer

The inventory conversion period ends when the inventory is sold, not when it is paid for with cash.

Question 16

Accruals are "free" capital in the sense that no explicit interest must be paid on accruals.

Accepted Answer

Accruals are considered free capital because they represent the accumulation of funds that a company has earned but has not yet paid out as expenses or dividends. Unlike debt or equity financing, there is no explicit interest or dividend payment associated with accruals. However, there is an opportunity cost associated with using accruals, as the company could choose to invest those funds elsewhere to generate a return.

Question 17

Pledging of receivables involves the sale of accounts receivable.

Accepted Answer

Pledging of receivables involves using accounts receivable as collateral for a loan, not the sale of those receivables.

Question 18

An informal line of credit and a revolving credit agreement are similar except that a line of credit creates a legal obligation for the bank.

Accepted Answer

An informal line of credit and a revolving credit agreement are similar in that they both allow the borrower to borrow funds up to a certain limit and repay the borrowed amount along with interest. However, a revolving credit agreement creates a legal obligation for the borrower to repay the borrowed amount, whereas an informal line of credit does not have a formal agreement outlining the terms of borrowing and repayment, and therefore does not create a legal obligation.

Question 19

Since depreciation is a noncash charge,it neither appears on,nor has any effect on,the cash budget.

Accepted Answer

Depreciation, while a noncash charge and not directly affecting the cash budget, impacts it indirectly through its effect on taxes. Depreciation reduces taxable income, thereby affecting the cash outflows for taxes in the cash budget.

Question 20

When the accounts receivable turnover and payables deferral period are decreased,a firm's cash conversion cycle will be lengthened.

Accepted Answer

A shorter accounts receivable turnover and a longer payables deferral period both mean that the company takes longer to convert sales into cash. This is reflected in a lengthening of the cash conversion cycle.

Quiz 17: Working Capital Management and Short-Term Financing