[SOURCE] Midterms II Flashcards
Small business firms are generally unable to use which of the following sources of short-term funds
a. Bank loan
b. Trade credit
c. Commercial paper
d. Floating lien
ANS: c. Commercial paper.
BASIS: Commercial paper is typically issued by large, creditworthy firms, making it inaccessible to most small businesses.
Which type of inventory financing provides the least amount of security to the lender
a. Public warehousing arrangement
b. Field warehousing agreement
c. Trust receipt
d. Blanket lien
ANS: d. Blanket lien.
BASIS: A blanket lien gives the lender a claim over all inventory but does not provide direct control or security over specific inventory items.
The net effect of a compensating balance requirement on a loan from the viewpoint of the borrower is
a. The effective borrowing costs will be lower than if the compensating balance were not required
b. The effective borrowing costs will be higher than if the compensating balance were not required
c. The compensating balance has no effect on financing costs
d. The compensating balance will seldom be used if the loan maturity is less than 5 years
ANS: b. The effective borrowing costs will be higher than if the compensating balance were not required.
BASIS: A compensating balance reduces the effective loan amount available to the borrower while interest is still charged on the full principal, increasing the cost of borrowing. (Investopedia)
Factoring is a credit arrangement
a. which involves the outright sale of accounts receivable to a factor
b. which should be used only as a last resort when all other sources of financing fail
c. in which the factor is free to request new receivables for those accounts it deems uncollectible
d. in which the cash advances from the factor is essentially a loan secured by the eventual collection of the receivables factored
ANS: a. which involves the outright sale of accounts receivable to a factor.
BASIS: Factoring allows businesses to sell their accounts receivable to a third party (factor) in exchange for immediate cash, improving liquidity. (Investopedia)
If a firm had been extending trade credit on a 2/10, net 30 basis, what change would be expected on the statement of financial position of its customers if the firm went to a net cash 30 policy
a. increased payables
b. increased payables and increased bank loans
c. increased receivables
d. decreased receivables and increased bank loans
ANS: a. increased payables.
BASIS: Removing the early payment discount forces customers to take longer to pay, increasing their accounts payable. (Corporate Finance Institute)
Inventory used as collateral should generally not be highly
a. perishable
b. marketable
c. identifiable
d. durable
ANS: a. perishable.
BASIS: Perishable inventory loses value quickly and cannot serve as reliable collateral for secured loans. (Investopedia)
All of the following are types of trade credit except
a. Open accounts
b. Notes payable
c. Lines of credit
d. Trade acceptances
ANS: c. Lines of credit.
BASIS: Trade credit refers to the credit extended by suppliers to businesses for purchasing goods and services. Open accounts, notes payable, and trade acceptances are all forms of trade credit. However, a line of credit is a revolving credit facility provided by financial institutions, not a form of trade credit. (Source: Corporate Finance Institute)
Pepper Company changed from a traditional manufacturing philosophy to just-in-time (JIT) technology. What are the expected effects of this change on Pepper’s inventory turnover and inventory as a percentage of total assets reported on Pepper’s balance sheet?
Inventory Turnover - Inventory Percentage
a. Decrease – Decrease
b. Decrease – Increase
c. Increase – Decrease
d. Increase – Increase
ANS: c. Increase – Decrease.
BASIS: Just-in-time (JIT) manufacturing minimizes inventory levels by ordering raw materials only when needed, which increases inventory turnover. Since fewer inventories are held, inventory as a percentage of total assets decreases. (Source: Investopedia)
Commercial paper tends to be quite popular with large, profitable corporations because
a. Even though interest costs are higher than the interest on ordinary bank loans, the interest is tax-deductible.
b. Interest costs are lower than the interest on ordinary bank loans, and compensating balances are not required of borrowers.
c. The market distribution for commercial paper is very narrow.
d. Purchasers of commercial paper typically use this type of investment on a long-term basis.
ANS: b. Interest costs are lower than the interest on ordinary bank loans, and compensating balances are not required of borrowers.
BASIS: Commercial paper is an unsecured short-term debt instrument issued by corporations to meet short-term funding needs. It is favored by large firms because it usually carries a lower interest rate than bank loans and does not require collateral or compensating balances. (Source: Corporate Finance Institute)
Which of the following statements concerning commercial paper is correct?
a. Commercial paper is secured debt of large, financially strong firms.
b. Maturities of commercial paper generally exceed nine months.
c. Commercial paper interest rates are typically 1.25 to 1.50 percentage points above the stated prime rate.
d. None of the above statements is correct.
ANS: d. None of the above statements is correct.
BASIS: Commercial paper is an unsecured form of short-term debt, not secured. Its maturity typically does not exceed 270 days to avoid SEC registration. Additionally, commercial paper interest rates are usually lower than bank loan rates, not necessarily 1.25 to 1.50 percentage points above the prime rate. (Source: U.S. Securities and Exchange Commission)
When a specified level of safety stock is carried for an item in inventory, the average inventory level for that item
a. Decreases by the amount of the safety stock.
b. Is one-half the level of the safety stock.
c. Increases by one-half the amount of the safety stock.
d. Increases by the number of units of the safety stock.
ANS: d. Increases by the number of units of the safety stock.
BASIS: Safety stock is additional inventory maintained to mitigate stockouts. When safety stock is held, the average inventory level increases by the number of units designated as safety stock. (Source: Inventory Management Principles – APICS)
Stretching accounts payable is likely to do all of the following except
a. Increase the cost of foregoing a cash discount.
b. Lower the buyer’s credit rating.
c. Damage relationships with suppliers.
d. Lead to refusal of credit by suppliers.
ANS: c. Damage relationships with suppliers.
BASIS: Stretching accounts payable refers to delaying payments to suppliers beyond agreed terms. While it may impact cash flow positively in the short term, it can damage supplier relationships, leading to possible credit refusals or stricter payment terms. (Source: Harvard Business Review)
The principal difference between factoring and pledging receivables rests in the fact that in factoring
a. The accounts receivable are merely pledged as security for a loan.
b. The financial institution factoring the accounts reserves the right to substitute newer receivables for those accounts that appear difficult to collect.
c. The accounts receivable are pledged on a non-notification basis.
d. The accounts receivable are sold outright to a financial institution.
ANS: d. The accounts receivable are sold outright to a financial institution.
BASIS: In factoring, a company sells its receivables to a financial institution at a discount, transferring ownership and collection responsibility. Pledging, on the other hand, involves using receivables as collateral for a loan without transferring ownership. (Source: Investopedia)
What happens to the cost of a foregone cash discount as the number of days between the end of the discount period and the end of the credit period increases?
a. Rises.
b. Falls.
c. Remains constant.
d. Fluctuates erratically.
ANS: b. Falls.
BASIS: The cost of a foregone cash discount is effectively the opportunity cost of not taking the discount. As the number of days between the end of the discount period and the credit period increases, the annualized cost of not taking the discount decreases. (Source: Financial Management by Brigham & Ehrhardt)
The financing of the basic level of current assets by issuing commercial paper is inconsistent with
a. The maximization of shareholders’ wealth.
b. The objective of matching the maturities of assets and liabilities.
c. The goal of minimizing the cost of debt financing.
d. The expectation that long-term interest rates will decrease in the coming year.
ANS: b. The objective of matching the maturities of assets and liabilities.
BASIS: Commercial paper is a short-term financing instrument, typically used for temporary working capital needs. Using it to finance the basic level of current assets disrupts the matching principle, which suggests that long-term assets should be financed with long-term liabilities. (Source: Financial Management by Brigham & Ehrhardt)
A firm which finances through a factor
a. Maintains a compensating balance.
b. Uses another company to endorse or guarantee a loan.
c. Sells approved accounts receivable without recourse.
d. Uses inventory as collateral for a loan.
ANS: c. Sells approved accounts receivable without recourse.
BASIS: Factoring involves selling receivables to a financial institution (the factor) at a discount. “Without recourse” means that the factor assumes the risk of non-payment, removing the liability from the original firm. (Source: Investopedia)
Determining the appropriate level of working capital for a firm requires
a. Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance these assets.
b. Changing the capital structure and dividend policy of the firm.
c. Maintaining short-term debt at the lowest possible level because it is generally more expensive than long-term debt.
d. Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency.
ANS: d. Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency.
BASIS: Proper working capital management ensures liquidity while minimizing insolvency risk. The balance between current assets and liabilities directly affects a firm’s ability to meet short-term obligations. (Source: Corporate Finance by Ross, Westerfield, & Jaffe)
Given that each of the following short-term sources is available, which source of financing is likely to have the highest cost for a small business?
a. Trade credit
b. Commercial bank loan
c. Advances by owners
d. Accruals
ANS: a. Trade credit
BASIS: While trade credit offers convenience, suppliers often charge higher implicit interest rates for late payments or early payment discounts foregone, making it a costly financing option for small businesses. (Source: Small Business Financial Management – Harvard Business Review)
Which of the following is not a negotiated source of short-term financing?
a. Bank loan
b. Factoring
c. Open account
d. Warehouse receipt loan
ANS: c. Open account
BASIS: Negotiated sources of short-term financing involve formal agreements between the borrower and the lender. Open account financing is informal, as suppliers extend credit without a specific agreement, making it non-negotiated. (Source: Fundamentals of Financial Management by Brigham & Houston)
To evaluate the efficiency of purchase transactions, management decides to calculate the economic order quantity for a sample of the company’s products. To calculate the economic order quantity, management would need data for all of the following, except:
a. Volume of product sales
b. Purchase prices of the products
c. The fixed cost of ordering products
d. Volume of products in inventory
ANS: d. Volume of products in inventory
BASIS: Economic order quantity (EOQ) focuses on minimizing the total cost of ordering and holding inventory. It requires demand (sales volume), ordering cost, and holding cost but does not directly require the volume of products in inventory. (Source: Operations and Supply Chain Management by Jacobs & Chase)
Which one of the following is a spontaneous source of financing?
a. Notes payable
b. Prepaid interest
c. Long-term debt
d. Trade credit
ANS: d. Trade credit
BASIS: Spontaneous financing arises automatically with business operations. Trade credit is a prime example, as suppliers extend credit without formal financing agreements, unlike notes payable or long-term debt. (Source: Financial Management: Theory & Practice by Brigham & Ehrhardt)
The principal advantage of using commercial paper as a short-term financing instrument is that it:
a. Is generally cheaper than a commercial bank loan
b. Is readily available to almost all companies
c. Offers security, i.e., collateral, to the lender
d. Can be purchased without commission costs
ANS: a. Is generally cheaper than a commercial bank loan
BASIS: Commercial paper is an unsecured, short-term debt instrument issued by corporations with strong credit ratings. It typically carries lower interest rates than commercial bank loans. (Source: Investments by Bodie, Kane & Marcus)
A small retail business would most likely finance its merchandise inventory with:
a. Commercial paper
b. A terminal warehouse receipt loan
c. A line of credit
d. A chattel mortgage
ANS: c. A line of credit
BASIS: A line of credit is a flexible financing option that allows businesses to borrow funds up to a predetermined limit as needed. This makes it an ideal choice for financing inventory, especially for small retail businesses that need to manage cash flow fluctuations. (Source: Fundamentals of Corporate Finance by Ross, Westerfield & Jordan)
