Question 1

If a firm's customers is stretching its accounts payable,this may be a nuisance,but it does not represent a real financial cost to the firm as long as the customer periodically pays off its entire balance.

Accepted Answer

Stretching accounts payable can represent a real financial cost to the firm if the firm incurs additional costs such as interest expenses or loses early payment discounts. It can also affect the firm's cash flow and ability to pay its own bills and expenses in a timely manner.

Question 2

A firm constructing a new manufacturing plant and financing it with short-term loans that are scheduled to be converted to first mortgage bonds when the plant is completed would want to separate the construction loan from its other current liabilities associated with working capital management.

Accepted Answer

It is common practice to separate long-term financing for capital expenditures, such as constructing a new manufacturing plant, from short-term working capital needs. This allows for better management of the different types of financing and ensures that the long-term financing is not at risk of being used for short-term needs. Therefore, the firm would want to separate the construction loan from its other current liabilities associated with working capital management.

Question 3

The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt.Added risk stems from greater variability of interest costs on short-term debt.Even if its long-term prospects are good,the firm's lender may not renew a short-term loan if the firm is even temporarily unable to repay it.

Accepted Answer

This statement is true as short-term credit carries a higher risk due to the variability of interest costs and the fact that lenders may not renew the loan if the firm is unable to repay it. Long-term debt, on the other hand, provides more stability and certainty for the firm.

Question 4

If a firm's suppliers stop offering discounts,then its use of trade credit is more likely to increase than to decrease.

Accepted Answer

If a firm's suppliers stop offering discounts, it means the firm has less access to affordable credit. In such a situation, the firm may be more likely to rely on trade credit to finance its operations, as it may be the only viable source of credit available to the firm. Therefore, the use of trade credit is more likely to increase than to decrease.

Question 5

When deciding whether or not to take a trade discount,the cost of borrowing from a bank should be compared to the cost of trade credit to determine if the cash discount should be taken.

Accepted Answer

It is true that the cost of borrowing from a bank should be compared to the cost of trade credit in order to determine whether or not to take a trade discount. This analysis can help a company make an informed decision about whether to pay early to receive a cash discount or to hold onto their cash and pay the full amount at a later date.

Question 6

If a firm fails to take trade credit discounts,then it may cost the firm some money,but generally such a policy has a negligible effect on the firm's income statement and no effect on its balance sheet.

Accepted Answer

Failing to take trade credit discounts can significantly increase the cost of purchases, affecting both the income statement through higher expenses and the balance sheet by potentially increasing liabilities or reducing cash assets.

Question 7

A firm is said to be using costly trade credit when its accounts payable are extended beyond the discount period and an explicit cost is shown on the foregone discounts.

Accepted Answer

The answer of A firm is said to be using...

Question 8

A revolving credit agreement is a formal line of credit often used by large firms.The firm generally must pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Accepted Answer

This statement accurately describes a revolving credit agreement.

Question 9

If a firm is involuntarily stretching its accounts payable,then this is probably a sign that it is undercapitalized,that is,that it needs more working capital to support its operations.

Accepted Answer

When a firm is stretching its accounts payable, it means that it is taking longer to pay its bills to suppliers. This can be a sign that the firm does not have enough cash to make payments on time, indicating a lack of working capital. Therefore, Option A is true, and Option B is false.

Question 10

The calculated cost of trade credit for a firm that buys on terms of 2/10,net 30,is lower (other things held constant) if the firm pays in 40 days than in 30 days.

Accepted Answer

The cost of trade credit is lower if the firm pays in 40 days because the firm gets to use the money for an extra 10 days without paying any interest.

Question 11

The calculated cost of trade credit can be reduced by paying late.

Accepted Answer

The answer of The calculated cost of trade credit can...

Question 12

If a firm is offered credit terms of 2/10,net 30,on its purchases,it is in the firm's financial interest to pay as early as possible during the discount period.

Accepted Answer

The answer of If a firm is offered credit terms...

Question 13

The fact that no explicit interest is paid on accruals,and that the firm can vary the level of these accounts,makes accruals an attractive and flexible source of funding to meet increased working capital needs.

Accepted Answer

The answer of The fact that no explicit interest is...

Question 14

The factoring of receivables involves the specific use of receivables as collateral for the loan.

Accepted Answer

Factoring of receivables involves selling the receivables to a third party (the factor) at a discount, not using them as collateral for a loan.

Question 15

The cost of an installment loan is always slightly less than twice the stated annual rate.

Accepted Answer

The cost of an installment loan is always slightly less than twice the stated annual rate because the interest is calculated on the unpaid balance of the loan, which decreases over time.

Question 16

Because money has time value,cash sales are always more profitable than credit sales.

Accepted Answer

The profitability of cash sales versus credit sales depends on various factors such as the cost of financing, the potential for increased sales through offering credit, and the risk of non-payment. Credit sales can lead to higher overall profits if they attract more customers and if the cost of offering credit is lower than the additional profit generated.

Question 17

Firms must have high credit quality in order to issue commercial paper; therefore,all commercial papers are equally risky.

Accepted Answer

While it is true that firms must have high credit quality to issue commercial paper, it does not mean that all commercial papers are equally risky. Credit ratings agencies assign different ratings to different commercial papers based on their assessment of the creditworthiness of the issuer, which can range from highly rated (low risk) to low rated (high risk). Therefore, commercial papers with different ratings carry different levels of risk to investors.

Question 18

The prime rate charged can vary greatly (e.g.,as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because particular banks develop particular clienteles,such as making loans to specialty retailers.

Accepted Answer

The prime rate is a benchmark interest rate used by banks and is usually uniform across major banks because it is largely influenced by the federal funds rate set by the Federal Reserve, not by individual bank policies or client bases.

Question 19

Long-term loan agreements always contain provisions,or covenants,that constrain the firm's future actions.Short-term credit agreements are just as restrictive in order to protect the interests of the lender.

Accepted Answer

Short-term credit agreements are generally less restrictive than long-term loan agreements because they are for shorter periods and involve smaller amounts of money, thus posing less risk to the lender.

Question 20

Discount loans are usually provided for terms of only 1 year or less.Their interest is paid together with the principal at the end of the loan.

Accepted Answer

Discount loans have interest deducted upfront, not paid at the end. The borrower receives the principal minus the interest at the start.

Quiz 17: Working Capital Management and Short-Term Financing