Fundamentals of Corporate Finance, 2nd Cdn. Ed. (Berk et al.

)
Chapter 20 Short-Term Financial Planning

20.1 Forecasting Short-Term Financing Needs

1) Firms need short-term financing to deal with seasonal working capital requirements, negative cash
flow shocks, or positive cash flow shocks.
Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

2) Which of the following are the three reasons that firms need short-term financing?
A) seasonalities, market frictions, and positive cash flow shocks
B) seasonalities, funding risk, and market frictions
C) negative cash flow shocks, positive cash flow shocks, and seasonalities
D) market frictions, negative cash flow shocks, and funding risk
E) positive cash flow shocks, negative cash flow shocks, and market frictions
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

3) Which of the following companies is most likely to have the greatest need for short-term financial
planning?
A) a company that mines sand for use in glass-making
B) a company that manufactures condiments such as ketchup
C) a company that produces advertisements for roadside billboards
D) a company that provides catering services for weddings
E) a utility company that provides electricity
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

4) Which of the following companies has the smallest need for short-term financial planning?
A) a company that produces Christmas decorations
B) a toy manufacturer
C) a company that makes condiments such as ketchup
D) a company that provides catering services for weddings
E) a retailer that sells bathing suits
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs
5) How does seasonality create fluctuations in a firm's net income over a year?
A) Cost of goods sold will rise and fall along with sales, while administrative and other costs will
remain relatively steady.
B) Cost of goods sold will rise when sales fall, and vice versa, while administrative and other costs will
remain relatively steady.
C) Cost of goods sold, along with administrative and other costs, will rise when sales fall, and vice
versa.
D) Cost of goods sold, along with administrative and other costs, will rise and fall along with sales.
E) Cost of goods sold, along with administrative and other costs, will remain relatively steady.
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

Use the table for the question(s) below.

Month J F M A M J J A S O N D
Net Income 8 5 6 6 6 6 6 6 6 42 20 7
Depreciation 2 2 1 2 2 1 2 2 2 2 2 2
Capital Expenditures 1 0 0 1 2 1 2 4 5 2 0 0
Accounts Receivable 16 2 3 2 1 1 2 1 3 18 22 12
Inventory 3 2 2 2 2 2 3 4 8 16 5 2
Accounts Payable 3 3 3 3 3 3 3 3 3 3 3 3

DressUp! is a clothing retailer specializing in costumery. The financial forecast for a year is shown in the
table above. All figures are in thousands of dollars.

6) During which of the following months are the firm's working capital needs the greatest?
A) April
B) June
C) September
D) October
E) November
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

7) During which of the following months does the firm have surplus cash?
A) April
B) June
C) September
D) October
E) November
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

Use the information for the question(s) below.

Azamel Cosmetics specializes in cosmetics which have high levels of UV protection. The above figures
show the anticipated sales over the next four quarters. Azamel carries inventory equal to 30% of next
quarter's sales, has accounts payable of 20% of next quarter's sales, and accounts receivable of 25% of
this quarter's sales.

8) If its net income is 12% of sales, in which quarter(s) is it expected that Azamel's seasonal working
capital needs will be the greatest?
A) Q1
B) Q2
C) Q3
D) Q4
E) Q5
Answer: C
Explanation: C)
Q1 Q2 Q3 Q4 Q5
Sales 1.8 2.4 8.4 3.2 2.1
Inventory 0.72 2.52 0.96 0.63
A/P 0.48 1.68 0.64 0.42
A/R 0.45 0.60 2.1 0.80
Net Income 0.216 0.288 1.008 0.384

Working Capital 0.69 1.44 2.42 1.01

Diff: 1 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs
9) If its net income is 12% of sales, in which quarter(s) is it expected that Azamel's seasonal working
capital needs will be the smallest?
A) Q1
B) Q2
C) Q3
D) Q4
E) Q5
Answer: A
Explanation: A)
Q1 Q2 Q3 Q4 Q5
Sales 1.8 2.4 8.4 3.2 2.1
Inventory 0.72 2.52 0.96 0.63
A/P 0.48 1.68 0.64 0.42
A/R 0.45 0.60 2.1 0.80
Net Income 0.216 0.288 1.008 0.384

Working Capital 0.69 1.44 2.42 1.01

Diff: 1 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs

Use the information for the question(s) below.

Glenside Industries is a domestic machinery manufacturer which specializes in the production of

snowblowers. The above figures show the anticipated sales over the next four quarters. Glenside carries
inventory equal to 25% of next quarter's sales, has accounts payable of 15% of next quarter's sales, and
accounts receivable of 23% of this quarter's sales.
10) If its net income is 10% of sales, in which quarter(s) is it expected that Glenside's seasonal working
capital needs will be the greatest?
A) Q1
B) Q2
C) Q3
D) Q4
E) Q5
Answer: D
Explanation: D)
Q1 Q2 Q3 Q4 Q5
Sales 2.0 0.3 0.4 4.2 2.7
Inventory 0.075 0.1 1.05 0.675
A/P 0.045 0.06 0.63 0.405
A/R 0.46 0.069 0.092 0.966
Net Income 0.2 0.03 0.04 0.42

Working Capital 0.49 0.109 0.512 1.236

Diff: 1 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs

11) If its net income is 10% of sales, in which quarter(s) is it expected that Glenside's seasonal working
capital needs will be the smallest?
A) Q1
B) Q2
C) Q3
D) Q4
E) Q5
Answer: B
Explanation: B)
Q1 Q2 Q3 Q4 Q5
Sales 2.0 0.3 0.4 4.2 2.7
Inventory 0.075 0.1 1.05 0.675
A/P 0.045 0.06 0.63 0.405
A/R 0.46 0.069 0.092 0.966
Net Income 0.2 0.03 0.04 0.42

Working Capital 0.49 0.109 0.512 1.236

Diff: 1 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs
12) Occasionally, a company will encounter circumstances in which cash flows are temporarily negative
for an unexpected reason. We refer to such a situation as
A) a liquidity shock.
B) a negative cash flow shock.
C) a negative liquidity shock.
D) a cash crunch.
E) a margin squeeze.
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

13) When a company analyzes its short-term financing needs, it typically examines cash flows at
A) monthly intervals.
B) yearly intervals.
C) quarterly intervals.
D) weekly intervals.
E) daily intervals.
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

14) Which of the following firms is likely to have the highest short-term financing needs?
A) a pharmaceutical manufacturer
B) a grocery store
C) an electric utility
D) a toy store
E) an internet service provider
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs
Use the table for the question(s) below.

The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $
millions):

Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145

15) In which quarter(s) are Hasbeen's seasonal working capital needs the greatest?
A) 4
B) 2
C) 3
D) 1
E) 1 and 2
Answer: C
Explanation: C)
Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145
Working Capital 765 1000 1105 990

Working Capital = Cash + AR + Inventory - AP.

Note quarter 3 has the highest working capital needs.
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs
16) In which quarter(s) are Hasbeen's seasonal working capital needs the smallest?
A) 4
B) 2
C) 3
D) 1
E) 3 and 4
Answer: D
Explanation: D)
Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145
Working Capital 765 1000 1105 990

Working Capital = Cash + AR + Inventory - AP.

Note quarter 1 has the lowest working capital needs.
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs
Use the table for the question(s) below.

The quarterly working capital levels for Fancy Weddings, Inc are presented in the following table (in $
millions):

Quarter 1 2 3 4
Cash 825 175 175 900
Accounts Receivable 585 1,245 1,760 800
Inventory 160 250 250 115
Accounts Payable 735 910 1,255 945

17) In which quarter(s) are Fancy's seasonal working capital needs the greatest?
A) 1
B) 2
C) 3
D) 4
E) 1 and 2
Answer: C
Explanation: C)
Quarter 1 2 3 4
Cash 825 175 175 900
Accounts Receivable 585 1,245 1,760 800
Inventory 160 250 250 115
Accounts Payable 735 910 1,255 945
Working Capital 835 760 930 870

Working Capital = Cash + AR + Inventory - AP.

Note quarter 3 has the highest working capital needs.
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs
18) In which quarter(s) are Fancy's seasonal working capital needs the smallest?
A) 1
B) 2
C) 3
D) 4
E) 3 and 4
Answer: B
Explanation: B)
Quarter 1 2 3 4
Cash 825 175 175 900
Accounts Receivable 585 1,245 1,760 800
Inventory 160 250 250 115
Accounts Payable 735 910 1,255 945
Working Capital 835 760 930 870

Working Capital = Cash + AR + Inventory - AP.

Note quarter 2 has the smallest working capital needs.
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.1 Forecast cash flows and short-term financing needs

19) How can positive cash flow shocks affect short-term financing needs?
Answer: If the positive cash flow shock is in the form of a growth opportunity that requires an up front
investment, there will be a temporary need for short-term financing.
Diff: 2 Type: SA
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs

20) How does seasonality lead to short-term financing needs?

Answer: When sales are seasonal, firms may have surplus cash in some months and cash shortfalls in
other months. Due to timing differences, such firms often have short-term financing needs.
Diff: 2 Type: SA
Skill: Conceptual
Objective: 20.1 Forecast cash flows and short-term financing needs
20.2 The Matching Principle

1) According to the matching principle, short-term needs for funds should be financed by short-term
sources of funds; long-term need for funds should be financed by long-term sources of funds.
Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

2) Since permanent working capital is invested in short-term assets, it should be financed with short-
term sources of funds.
Answer: FALSE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

3) Which short-term financing policy states that short-term cash needs should be financed with short-
term debt and long-term cash needs should be financed with long-term sources of funds?
A) aggressive policy
B) evergreen credit
C) matching principle
D) conservatism principle
E) duration policy
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

4) What is permanent working capital?

A) the amount that a firm must keep invested in its short-term assets to support its continuing
operations
B) the difference between the actual level of investment in short-term assets and the amount that a firm
must keep invested in its short-term assets to support its continuing operations
C) the amount that a firm keeps invested in its short-term assets to support its continuing operations
which is financed by short-term debt
D) the amount that a firm keeps invested in its short-term assets to support its continuing operations
which is financed by long-term debt
E) the amount that a firm keeps invested in its short-term assets which is financed by debt
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
5) What is temporary working capital?
A) the amount that a firm must keep invested in its short-term assets to support its continuing
operations
B) the difference between the actual level of investment in short-term assets and the amount that a firm
must keep invested in its short-term assets to support its continuing operations
C) the amount that a firm keeps invested in its short-term assets to support its continuing operations
which are financed by short-term debt
D) the amount that a firm keeps invested in its short-term assets to support its continuing operations
which are financed by long-term debt
E) the amount that a firm keeps invested in its short-term assets which is financed by debt
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

6) Which of the following statements regarding how a firm should finance its cash needs is true?
A) Permanent working capital should be financed by long-term sources of funds, while temporary
working capital should be financed by short-term sources of funds.
B) Permanent working capital should be financed by short-term sources of funds, while temporary
working capital should be financed by long-term sources of funds.
C) Both permanent working capital and temporary working capital should be financed by short-term
sources of funds.
D) Both permanent working capital and temporary working capital should be financed by long-term
sources of funds.
E) Permanent working capital should be financed by long-term sources of funds, while temporary
working capital should only be paid for with cash.
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
Use the table for the question(s) below.

Q1 Q2 Q3 Q4
Minimum Cash Balance 800 800 800 800
Accounts Receivable 1400 800 700 3700
Inventory 1100 3100 5200 550
Accounts Payable (600) (600) (600) (600)

The data above shows the net working capital requirements for Blunderstone Shoes, a company that
makes waterproof boots. All figures are in thousands of dollars.

7) What can be considered the firm's permanent working capital?

A) $2,700,000
B) $3,300,000
C) $4,100,000
D) $4,450,000
E) $4,850,000
Answer: A
Explanation: A)
Q1 Q2 Q3 Q4
Min Cash Bal 800 800 800 800
Inventory 1100 3100 5200 550
A/C Payable (600) (600) (600) (600)
A/C Receivable 1400 800 700 3700

Working Capital 2700 4100 6100 4450

Minimum working capital = permanent working capital = $2,700,000

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
8) What are Blunderstone's temporary working capital requirements in the third quarter?
A) $2,700,000
B) $3,400,000
C) $5,450,000
D) $6,100,000
E) $1,750,000
Answer: B
Explanation: B)
Q1 Q2 Q3 Q4
Min Cash Bal 800 800 800 800
Inventory 1100 3100 5200 550
A/C Payable (600) (600) (600) (600)
A/C Receivable 1400 800 700 3700

Working Capital 2700 4100 6100 4450

Temporary working capital = actual working cap - min working cap = $6100 - $2700 = $3400

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

9) What are Blunderstone's temporary working capital requirements in the fourth quarter?
A) $2,700,000
B) $3,400,000
C) $5,450,000
D) $4,450,000
E) $1,750,000
Answer: E
Explanation: E)
Q1 Q2 Q3 Q4
Min Cash Bal 800 800 800 800
Inventory 1100 3100 5200 550
A/C Payable (600) (600) (600) (600)
A/C Receivable 1400 800 700 3700

Working Capital 2700 4100 6100 4450

Temporary working capital = actual working cap - min working cap = $4450 - $2700 = $1750

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
Use the table for the question(s) below.

Q1 Q2 Q3 Q4
Minimum Cash Balance 300 300 300 300
Accounts Receivable 80 640 360 100
Inventory 1060 420 60 440
Accounts Payable (330) (330) (330) (330)

The data above shows the net working capital requirements for Flinder's Camping, a company that
makes tents. All figures are in thousands of dollars.

10) What can be considered the firm's permanent working capital?

A) $390,000
B) $510,000
C) $720,000
D) $1,030,000
E) $640,000
Answer: A
Explanation: A)
Q1 Q2 Q3 Q4
Min Cash Bal 300 300 300 300
Inventory 1060 420 60 440
A/C Payable (330) (330) (330) (330)
A/C Receivable 80 640 360 100

Working Capital 1110 1030 390 510

Minimum working capital = permanent working capital = $390,000

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
11) What are Flinder's temporary working capital needs in the quarter in which they are greatest?
A) $390,000
B) $510,000
C) $720,000
D) $1,111,000
E) $650,000
Answer: C
Explanation: C)
Q1 Q2 Q3 Q4
Min Cash Bal 300 300 300 300
Inventory 1060 420 60 440
A/C Payable (330) (330) (330) (330)
A/C Receivable 80 640 360 100

Working Capital 1110 1030 390 510

Temporary working capital = max working capital - min working capital = $1110 - $390 = $720,000

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

12) What are Flinder's temporary working capital needs in the fourth quarter?
A) $390,000
B) $510,000
C) $720,000
D) $120,000
E) $650,000
Answer: D
Explanation: D)
Q1 Q2 Q3 Q4
Min Cash Bal 300 300 300 300
Inventory 1060 420 60 440
A/C Payable (330) (330) (330) (330)
A/C Receivable 80 640 360 100

Working Capital 1110 1030 390 510

Temporary working capital = actual working capital - min working capital = $510 - $390 = $120,000

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
13) Which of the following best describes an aggressive financing policy?
A) financing part or all of the permanent working capital with short-term debt
B) financing part or all of the permanent working capital with long-term debt
C) financing part or all of the temporary working capital with short-term debt
D) financing part or all of the temporary working capital with long-term debt
E) financing part or all of the temporary working capital with equity
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

14) Which of the following best describes a conservative financing policy?

A) financing part or all of the permanent working capital with short-term debt
B) financing part or all of the permanent working capital with long-term debt
C) financing part or all of the temporary working capital with short-term debt
D) financing part or all of the temporary working capital with long-term debt
E) financing part or all of the temporary working capital with equity
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

15) Bradford Maintenance, a firm that provides lawn care services, has some seasonal variations in its
cash flow needs, since much of the demand for its services is in the summer months. It uses long-term
sources of funds to finance its assets such as its fleet of vehicles and lawn-care equipment and for the
permanent funds that it must have at all times. For its peak seasonal needs it uses some short-term debt.
What best describes the financial policy being followed by Bradford?
A) matching
B) conservative
C) integrated
D) seasonal
E) aggressive
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
Use the table for the question(s) below.

The quarterly working capital levels for Hasbeen Toys are presented in the following table (in $
millions):

Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145

16) The permanent working capital needs for Hasbeen Toys is closest to:
A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million
E) $640 million
Answer: D
Explanation: D)
Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145
Working capital 765 1000 1105 990

Working capital = Cash + AR + inventory - AP

Permanent working capital equals the minimum level of working capital which occurs at quarter 1 in
the amount of $765 million.
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
17) The temporary working capital needs for Hasbeen Toys in quarter 1 is closest to:
A) $0 million
B) $340 million
C) $770 million
D) $845 million
E) $640 million
Answer: A
Explanation: A)
Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145
Working capital 765 1000 1105 990

Working capital = Cash + AR + inventory - AP

Permanent working capital equals the minimum level of working capital which occurs at quarter 1 in
the amount of $765 million.

Temporary working capital = working capital - permanent working capital

= $765 - $765 = $0 million
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
18) The temporary working capital needs for Hasbeen Toys in quarter 3 is closest to:
A) $845 million
B) $0 million
C) $770 million
D) $340 million
E) $660 million
Answer: D
Explanation: D)
Quarter 1 2 3 4
Cash 605 625 175 1000
Accounts Receivable 585 745 1260 760
Inventory 410 540 725 375
Accounts Payable 835 910 1055 1145
Working capital 765 1000 1105 990

Working capital = Cash + AR + inventory - AP

Permanent working capital equals the minimum level of working capital which occurs at quarter 1 in
the amount of $765 million.

Temporary working capital = working capital - permanent working capital

= $1105 - $765 = $340 million
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

19) How can the application of the matching principle increase firm value?
Answer: The existence of market frictions can make it costly for a firm to hold high cash balances or
obtain financing on short notice. Firms can increase their value by adopting a policy that minimizes
these kinds of costs.
Diff: 2 Type: SA
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

20) Why should permanent working capital be financed with long-term sources of funds?
Answer: Permanent working capital is the amount that a firm must keep invested in its short-term
assets to support its continuing operations. Because this investment in working capital is required as
long as the firm remains in business, it constitutes a long-term investment, and should be financed with
long-term sources of funds due to lower transaction costs.
Diff: 2 Type: SA
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources
21) If the benefit of a lower rate from short-term debt is offset by the risk that the firm will have to
refinance at a higher rate, why would a firm choose an aggressive financing policy?
Answer: An aggressive financing policy might be beneficial if market imperfections, such as agency
costs and asymmetric information, are important. The value of short-term debt is less affected by
management's actions or information, and will thus have lower agency and lemons costs, providing
value to shareholders.
Diff: 3 Type: SA
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

22) How can a conservative financing policy reduce firm value?

Answer: With a conservative financing policy there will be periods when excess cash is available. In an
imperfect capital market, this cash will earn a below-market interest rate, thereby reducing firm value. It
also increases the possibility that managers of the firm will use this excess cash unproductively.
Diff: 3 Type: SA
Skill: Conceptual
Objective: 20.2 Understand the principle of matching short-term needs to short-term funding sources

20.3 Short-Term Financing with Bank Loans

1) The prime rate is the rate banks charge all but their largest customers, who can negotiate a sub-prime
rate.
Answer: FALSE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

2) An uncommitted line of credit is obtained through a nonbinding, informal agreement.

Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

3) Which of the following best describes a loan where the firm must pay interest on the loan and pay
back the principal in one lump sum at the end of the loan?
A) single, end-of-period payment loan
B) promissory note
C) bridge loan
D) committed line of credit
E) uncommitted line of credit
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs
4) Which of the following best describes a bank loan arrangement where a bank agrees to lend a firm
any amount up to a stated maximum in an informal agreement which does not legally bind the bank to
provide the funds?
A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit
E) revolving line of credit
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

5) Which of the following bank loan arrangements is typically accompanied by a requirement that the
firm maintain a minimum level of deposits with the lending bank and restricts the level of the
borrowing firm's working capital?
A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit
E) discount loan
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

6) Which of the following is a committed line of credit with no fixed maturity?

A) a bridge loan
B) evergreen credit
C) a promissory note
D) a blanket lien
E) discount loan
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

7) A petroleum exploration company takes a short-term bank loan in order to finance the purchase of
several truck-mounted, vibroseis shakers, which have unexpectedly come onto the market at a good
price. Once the purchase is made, the company will obtain long-term financing. Which of the following
best describes the short-term loan the company has taken?
A) a single, end-of-period payment loan
B) a promissory note
C) a bridge loan
D) an uncommitted line of credit
E) evergreen credit
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs
8) Bandolier Bicycles has a commited line of credit with a maximum of $450,000 and interest rate of 4%
(EAR). The loan has a commitment fee of 0.3% (EAR). If the firm borrows $375,000 at the start of the
year and repays it at the end of the year, what is the total cost of the loan?
A) $15,225
B) $15,000
C) $18,225
D) $18,000
E) $16,125
Answer: A
Explanation: A) Interest on borrowed funds = 0.04 × (375,000) = $15,000
Commitment fee paid on unused portion = 0.003 × (75,000) = $225
Total cost of loan = $15,225
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

9) Ahab's Army Surplus has a commited line of credit with a maximum of $1.2 million and interest rate
of 3.5% (EAR). The loan has a commitment fee of 0.45% (EAR). If the firm borrows $900,000 at the start
of the year and repays it at the end of the year, what is the total cost of the loan?
A) $42,000
B) $35,550
C) $43,350
D) $32,850
E) $31,500
Answer: D
Explanation: D) Interest on borrowed funds = 0.035 × (900,000) = $31,500
Commitment fee paid on unused portion = 0.0045 × (300,000) = $1,350
Total cost of loan = $32,850
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

10) Katie's Karate Dojo has a commited line of credit with a maximum of $350,000 and interest rate of
6% (EAR). The loan has a commitment fee of 0.5% (EAR). If the firm borrows $300,000 at the start of the
year and repays it at the end of the year, what is the total cost of the loan?
A) $18,000
B) $18,250
C) $19,500
D) $21,250
E) $21,000
Answer: B
Explanation: B) Interest on borrowed funds = 0.06 × (300,000) = $18,000
Commitment fee paid on unused portion = 0.005 × (50,000) = $250
Total cost of loan = $18,250
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs
11) Pipeline Pharmaceuticals has a one-year $2 million line of credit at an interest rate of 5% (EAR). The
loan has a loan origination fee of 2%. What is the actual interest rate paid?
A) 7%
B) 7.14%
C) 5%
D) 7.1%
E) 5.9%
Answer: B
Explanation: B) Origination fee = 0.02 × ($2 million) = $40,000
Loan amount = $2 million - $40,000 = $1.96 million
Interest paid = $2m × 0.05 = $100,000
Interest rate = 2.1 million/1.96 million - 1 = 7.14%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

12) Bhupinder's Bakery has a one-year $300,000 line of credit at an interest rate of 6% (EAR). The loan
has a loan origination fee of 1%. What is the actual interest rate paid?
A) 7%
B) 6.7%
C) 7.07%
D) 7.14%
E) 6%
Answer: C
Explanation: C) Origination fee = 0.01 × ($300,000) = $3,000
Loan amount = $300,000 - $3,000 = $297,000
Interest paid = $300,000 × .06 = $18,000
Interest rate = 318,000/297,000 - 1 = 7.07%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

13) Strata Services has a three month $450,000 line of credit at an APR of 8%. The loan has a loan
origination fee of 1.5%. What is the actual three-month interest rate paid expressed as an EAR?
A) 9.8%
B) 9.5%
C) 14.75%
D) 8.24%
E) 15%
Answer: E
Explanation: E) Origination fee = 0.015 × ($450,000) = $6,750
Loan amount = $450,000 - $6,750 = $443,250
Interest paid = $450,000 × 8% × 3/12 = $9,000
Three-month Interest rate = 459,000/443,250 - 1 = 3.55%
EAR = 1.0355^(12/3) - 1 = 15%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

14) Gemini Real Estate is offered a $2 million line of credit for four months at an APR of 9%. This loan
has a loan origination fee of 1.5%. What is the actual four-month interest rate paid, expressed as an
EAR?
A) 4.57%
B) 9.68%
C) 12.44%
D) 14.34%
E) 11.14%
Answer: D
Explanation: D) Origination fee = 0.015 × ($2,000,000) = $30,000
Loan amount = $2,000,000 - $30,000 = $1,970,000
Interest paid = $2,000,000 × 9% × 4/12 = $60,000
four-month interest rate = 2,060,000 / 1,970,000 = 1.045685
EAR = 1.045685(12/4) -1 = 14.34%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

15) ABX Corp. is offered a $1.4 million line of credit for nine months at an APR of 7.5%. This loan has a
loan origination fee of 1%. What is the actual nine-month interest rate paid, expressed as an EAR?
A) 7.50%
B) 7.57%
C) 6.69%
D) 8.92%
E) 9.02%
Answer: E
Explanation: E) Origination fee = 0.01 × ($1,400,000) = $14,000
Loan amount = $1,400,000 - $14,000 = $1,386,000
Interest paid = $1,400,000 × 7.5% × 9/12 = $78,750
nine-month interest rate = 1,478,750 / 1,386,000 = 1.066919
EAR = 1.066919(12/9) - 1 = 9.02%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs
16) Conway's Roofing Services is offered a $1 million line of credit for three months at an APR of 8%.
The bank requires that the firm keep an amount equal to 12% of the loan principal in a non-interest-
earning account with the bank as long as the loan remains outstanding. What is the actual three-month
interest rate paid, expressed as an EAR?
A) 9.41%
B) 24.40%
C) 60.30%
D) 80.40%
E) 31.45%
Answer: A
Explanation: A) Compensating balance = 0.12 × 1,000,000 = $120,000
Loan amount = $1,000,000 - $120,000 = $880,000
Total amount payable = 1,000,000 × (1 + 0.08 / 4) = $1,020,000
Amount owed = $1,020,000 - $120,000 = $900,000
Actual interest rate paid = 900,000/880,000 = 1.02273
Expressing as EAR = 1.02273(12/3) - 1 = 9.41%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

17) Jim's Electrical is offered a $400,000 line of credit for six months at an APR of 9%. The bank requires
that the firm keep an amount equal to 5% of the loan principal in a non-interest-earning account with
the bank as long as the loan remains outstanding. What is the actual six-month interest rate paid,
expressed as an EAR?
A) 3.2%
B) 5.0%
C) 9.70%
D) 24.3%
E) 27.6%
Answer: C
Explanation: C) Compensating balance = 0.05 × 400,000 = $20,000
Loan amount = $400,000 - $20,000 = $380,000
Total amount payable = 400,000 × (1 + 0.09 / 2) = $418,000
Amount owed = $418,000 - $20,000 = $398,000
Actual interest rate paid = 398,000 / 380,000 = 1.04737
Expressing as EAR = 1.04737(12/6) - 1 = 9.70%%
Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs
18) Stuart Mining is offered a $4,000,000 line of credit for three months at an APR of 6%. The bank
requires that the firm keep an amount equal to 10% of the loan principal in an account with the bank as
long as the loan remains outstanding. This account pays 2% APR with quarterly compounding. What is
the actual three-month interest paid on this loan?
A) 1.6%
B) 6.6%
C) 12.6%
D) 14.6%
E) 60.9%
Answer: B
Explanation: B) Compensating balance = 0.1 × 4,000,000 = $400,000
Loan amount = $4,000,000 - $400,000 = $3,600,000
Amount earned on the compensating balance = 400,000 × (1 + 0.02 / 4) = $402,000
Total amount payable = 4,000,000 × (1 + 0.06 / 4) = $4,060,000
Amount owed = $4,060,000 - $402,000 = $3,658,000
Actual interest rate paid = 3,658,000 / 3,600,000 = 1.01611
Expressing as EAR = 1.01611(12/3) - 1 = 6.60%
Diff: 3 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

19) A short-term bank loan that is often used until a firm can arrange for long-term financing is called
A) a committed line of credit.
B) a short-term mortgage loan.
C) a bridge loan.
D) a single, end-of-period-payment loan.
E) evergreen credit
Answer: C
Diff: 1 Type: MC
Skill: Definition
Objective: 20.3 Know the different types of bank loans and their trade-offs

20) A written, legally binding agreement that obligates the bank to lend a firm any amount up to a
stated maximum, regardless of the financial condition of the firm (unless the firm is bankrupt) as long
as the firm satisfies any restrictions in the agreement is called
A) a bridge loan.
B) a single, end-of-period-payment loan.
C) a short-term mortgage loan.
D) a committed line of credit.
E) an uncommitted line of credit.
Answer: D
Diff: 1 Type: MC
Skill: Definition
Objective: 20.3 Know the different types of bank loans and their trade-offs
21) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. If this loan has
an origination fee of 1%, then the effective annual rate (EAR) for this loan is closest to:
A) 12.0%
B) 12.6%
C) 4.1%
D) 13.8%
E) 7.5%
Answer: B
Explanation: B) The origination fee is charged on the principal of the loan.
The amount of the fee is equal to 0.01 × $1,000,000 = $10,000,
so that the actual proceeds from the loan = $1,000,000 - $10,000 = $990,000.
The interest on the loan equals $1,000,000 × × 4 months = $30,000.

The actual four month interest rate is: - 1 = 0.040404 or 4.04%.

Expressing this rate as an EAR gives 1.040404(12/4) - 1 = 0.126176 or 12.62%.

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs

22) Luther Industries is offered a $1 million loan for four months at an APR of 9%. If Luther's bank
requires that the firm maintain a compensating balance equal to 10% of the loan amount in a non-
interest-earning account, then the effective annual rate EAR for this loan is closest to:
A) 10.3%
B) 12.6%
C) 14.4%
D) 71.5%
E) 21.1%
Answer: A
Explanation: A) The origination fee is charged on the principal of the loan.
The amount of the compensating balance is equal to 0.10 × $1,000,000 = $100,000,
so that the actual proceeds from the loan = $1,000,000 - $100,000 = $900,000.
The interest on the loan equals $1,000,000 × × 4 months = $30,000.

The actual four-month interest rate is: - 1 = 0.03333 or 3.333%.

Expressing this rate as an EAR gives 1.03333(12/4) - 1 = 0.1033 or 10.33%.

Diff: 2 Type: MC
Skill: Analytical
Objective: 20.3 Know the different types of bank loans and their trade-offs
23) What are commitment fees and what effect does it have on the loan?
Answer: Commitment fees are associated with a committed line of credit, thereby increasing the cost of
borrowing.
Diff: 1 Type: SA
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

24) What are loan origination fees and what effect does it have on the loan?
Answer: Banks charge a fee called loan origination fee to cover the costs of credit checks and legal fees.
This fee is paid when the loan is initiated, thereby adding to the cost of borrowing.
Diff: 1 Type: SA
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

25) What are compensating balance and what effect does it have on the loan?
Answer: Regardless of the loan structure, the bank may include a compensating balance requiring the
firm to maintain a balance with the bank. The bank may or may not pay interest on this compensating
balance. In either case, the compensating balance along with the interest earned, if any, should be taken
into account when calculating the cost of loan.
Diff: 1 Type: SA
Skill: Conceptual
Objective: 20.3 Know the different types of bank loans and their trade-offs

20.4 Short-Term Financing with Commercial Paper

1) Commercial paper is usually a more expensive source of funds than a short-term bank loan.
Answer: FALSE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

2) The interest on commercial paper is typically paid by selling it at an initial discount.

Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

3) Commercial paper is rated by credit rating agencies.

Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
4) What is the maximum maturity of commercial paper?
A) 60 days
B) 90 days
C) 180 days
D) one year
E) 270 days
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

5) A firm issues three-month commercial paper with a $250,000 face value and receives $244,000. What
is the EAR the firm is paying for these funds?
A) 10.2%
B) 9.8%
C) 9.6%
D) 10%
E) 9.4%
Answer: A
Explanation: A) Actual three-month interest rate paid = 250,000 / 244,000 - 1 = 2.459%
Expressing this as an EAR gives (1.02459)^4 - 1 = 10.2%.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

6) A firm issues four-month commercial paper with a $450,000 face value and receives $442,000. What is
the EAR the firm is paying for these funds?
A) 7.4%
B) 5.4%
C) 5.5%
D) 7.1%
E) 5.3%
Answer: C
Explanation: C) Actual four-month interest rate paid = 450,000 / 442,000 - 1 = 1.81%
Expressing this as an EAR gives (1.0181)^3 - 1 = 5.5%.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
7) A firm issues six-month commercial paper with a $1 million face value and receives $970,000. What is
the EAR the firm is paying for these funds?
A) 6%
B) 3%
C) 3.09%
D) 6.18%
E) 6.28%
Answer: E
Explanation: E) Actual six-month interest rate paid = 1,000,000 / 970,000 - 1 = 3.09%
Expressing this as an EAR gives (1.0309)^2 -1=6.28%.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

8) A firm issues one-month commercial paper with a $500,000 face value and receives $495,000. What is
the EAR the firm is paying for these funds?
A) 12.8%
B) 1.01%
C) 12.12%
D) 12%
E) 13.12%
Answer: A
Explanation: A) Actual six-month interest rate paid = 500 / 495 - 1 = 1.01%
Expressing this as an EAR gives (1.0101)^12 - 1 = 12.8%.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

9) A firm issues two-month commercial paper with a $200,000 face value and receives $196,000. What is
the EAR the firm is paying for these funds?
A) 12.5%
B) 12.6%
C) 12.9%
D) 12%
E) 12.2%
Answer: C
Explanation: C) Actual two-month interest rate paid = 200 / 196 - 1 = 2.04%
Expressing this as an EAR gives (1.0204)^6 - 1 = 12.9%.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
10) A firm issues three-month commercial paper with a $1,000,000 face value and pays an EAR of 7.4%.
What is the amount the firm receives?
A) $976,484
B) $981,836
C) $931,099
D) $982,318
E) $991,026
Answer: D
Explanation: D) (1.074)^1/4 - 1 = 1.8% per 3 months.; 1,000,000/(1.018) = $982,318
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

11) A firm issues four-month commercial paper with a $500,000 face value and pays an EAR of 8.26%.
What is the amount the firm receives?
A) $455,092
B) $487,306
C) $486,946
D) $490,177
E) $461,851
Answer: C
Explanation: C) (1.0826)^1/3 -1 = 2.6808% per 4 months.; 500,000/(1.026808) = $486,946
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

12) A firm issues six-month commercial paper with $100,000 face value and pays an EAR of 6.7%. What
is the amount the firm receives?
A) $93,197
B) $93,720
C) $94,994
D) $96,759
E) $96,809
Answer: E
Explanation: E) (1.067)^1/2 - 1 = 3.2957% per 6 months.; 100,000/(1.032957) = $96,809
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
13) Pembina Properties issues commercial paper with a face value of $450,000 and a maturity of three
months. The firm receives $442,000 when it sells the paper. If the prime rate is 9% APR compounded
quarterly, how much interest savings did Pembina realize by using commercial paper?
A) $1,945
B) $9,945
C) $8,000
D) $31,780
E) $1,625
Answer: A
Explanation: A) Using a financial calculator: PV = $442,000, I = 9/4, N = 1 ;
compute FV = $451,945; hence savings = $1,945.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

14) Montreal Metals issues commercial paper with a face value of $600,000 and a maturity of two
months. The firm receives $594,000 when it sells the paper. If the prime rate is 7% APR compounded
monthly, how much interest savings did Montreal Metals realize by using commercial paper?
A) $736
B) $7,020
C) $6,000
D) $950
E) $1,020
Answer: D
Explanation: D) Using a financial calculator: PV = $600,000, I = 7/12, N =2 ;
compute FV = $600,950; hence savings = $950.
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

15) Vancouver Ventilation issues commercial paper with a face value of $2 million and a maturity of six
months. The firm receives $1,950,000 when it sells the paper. If the prime rate is 7.5% APR compounded
quarterly, how much interest savings did Vancouver Ventilation realize by using commercial paper?
A) $25,703
B) $75,703
C) $23,811
D) $21,803
E) $25,000
Answer: C
Explanation: C) Using a financial calculator: PV = $1,950,000, I = 7.5/4, N = 2 ;
compute FV = $2,023,811; hence savings = $23,811
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
16) What is the term used for a short-term, unsecured debt sold by a large company to investors?
A) commercial paper
B) retail paper
C) wholesale paper
D) unsecured paper
E) junk bond
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

17) What is the term used for a short-term, unsecured debt sold by a large company to an intermediary,
who then resells the debt to investors in return for a fee for his or her services?
A) commercial paper
B) direct paper
C) dealer paper
D) unsecured paper
E) junk bond
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing

18) What is the term used for a short-term, unsecured debt sold by a large company to investors without
using an intermediary?
A) commercial paper
B) direct paper
C) dealer paper
D) unsecured paper
E) junk bond
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.4 Understand the use of commercial paper as an alternative to bank financing
20.5 Short-Term Financing with Secured Financing

1) The accounts receivable and inventory of a firm typically are used as collateral when issuing short-
term secured financing.
Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

2) A blanket lien exposes a lender to less risk and thus carries less interest than a trust receipt.
Answer: FALSE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

3) Which of the following best describes the agreement where a firm sells receivables to a lender and the
lender agrees to pay the firm the amount due from its customers at the end of the firm's payment
period, with the provision that the lender will receive payment from the borrower if the customers
default on their payments?
A) trust receipt
B) pledging of accounts receivable
C) factoring of accounts receivable with recourse
D) factoring of accounts receivable without recourse
E) floating lien
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

4) Which of the following best describes the agreement where a firm sells receivables to a lender and the
lender agrees to pay the firm the amount due from its customers at the end of the firm's payment
period, and where the lender's claim on the borrower's assets in the event of default is limited only to
explicitly pledged collateral?
A) trust receipt
B) pledging of accounts receivable
C) factoring of accounts receivable with recourse
D) factoring of accounts receivable without recourse
E) floating lien
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory
5) Which of the following best describes the agreement in which a lender reviews the credit sales of the
borrowing firm and decides which credit accounts it will accept as collateral for the loan?
A) trust receipt
B) pledging of accounts receivable
C) factoring of accounts receivable with recourse
D) factoring of accounts receivable without recourse
E) floating lien
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

6) Which of the following best describes the agreement where all of a firm's inventory is used to secure a
loan?
A) pledging of accounts receivable
B) factoring of accounts receivable with recourse
C) factoring of accounts receivable without recourse
D) floating lien
E) trust receipt
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

7) Which of the following types of loans bears the highest interest rate?
A) trust receipt
B) floating lien
C) field warehouse arrangement
D) public warehouse arrangement
E) floor planning
Answer: B
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

8) Which of the following best describes the type of loan in which distinguishable inventory items are
held in a trust as security for the loan?
A) floor planning
B) floating lien
C) field warehouse arrangement
D) public warehouse arrangement
E) blanket lien
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory
9) Which of the following types of loans would be best for an investor who wishes to reduce risk by
maintaining the tightest control over inventory?
A) trust receipt
B) floating lien
C) field warehouse arrangement
D) public warehouse arrangement
E) floor planning
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

10) What is a field warehouse arrangement?

A) a warehouse arrangement in which the inventory is stored and tracked by the lender on the lender's
premises
B) a warehouse arrangement in which the inventory is stored on the borrower's premises but is tracked
by the lender
C) a warehouse arrangement in which the inventory is stored by a business that exists for the sole
purpose of storing and tracking the inflow and outflow of inventory
D) a warehouse arrangement that is operated by a third party but is set up on the borrower's premises
in a separate area so that the inventory collateralizing the loan is kept apart from the borrower's main
plant
E) a warehouse arrangement in which the inventory is stored and tracked by the borrower on the
borrower's premises
Answer: D
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

11) What is a public warehouse arrangement?

A) a warehouse arrangement in which the inventory is stored and tracked by the lender on the lender's
premises
B) a warehouse arrangement in which the inventory is stored on the borrower's premises but is tracked
by the lender
C) a warehouse arrangement in which the inventory is stored by a business that exists for the sole
purpose of storing and tracking the inflow and outflow of inventory
D) a warehouse arrangement that is operated by a third party but is set up on the borrower's premises
in a separate area so that the inventory collateralizing the loan is kept apart from the borrower's main
plant
E) a warehouse arrangement in which the inventory is stored and tracked by the borrower on the
borrower's premises
Answer: C
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory
12) Which of the following is a financing arrangement in which the lender's claim on the borrower's
assets in the event of a default is limited to only explicitly pledged collateral?
A) without recourse
B) with recourse
C) without factoring
D) with factoring
E) without subordination
Answer: A
Diff: 1 Type: MC
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

13) Winnipeg Washing Machines wishes to borrow $1.5 million for one month. Using its inventory as
collateral, it can obtain a 10% (APR) loan. The lender requires that a warehouse arrangement be used,
with a warehouse fee of $8,500, payable at the end of the month. What is the firm's EAR for this loan?
A) 18.2%
B) 16.8%
C) 10.5%
D) 17%
E) 17.4%
Answer: A
Explanation: A) Using a financial calculator: PV = $1,500,000, I = 10/12, N = 1;
compute FV = $1,512,500; adding warehouse fees = $1,521,000;
Actual two-month rate = $1,521,000/$1,500,000 - 1 = 0.014 or 1.4%
EAR = 1.014^12 - 1 = 18.2%
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.5 Use financing secured by accounts receivable or inventory

14) Sask Seed wishes to borrow $3 million for two months. Using its inventory as collateral, it can obtain
a 9% (APR) loan. The lender requires that a warehouse arrangement be used, with a warehouse fee of
$9,000, payable at the end of the month. What is the firm's EAR for this loan?
A) 17.4%
B) 21.6%
C) 11.3%
D) 9.3%
E) 9%
Answer: C
Explanation: C) Using a financial calculator: PV = $3,000,000, I = 9/12, N = 2;
compute FV = $3,045,168; adding warehouse fees = $3,054,168;
Actual two-month rate = $3,054,168/$3,000,000 - 1 = 0.018 or 1.8%
EAR = 1.018^6 - 1 = 11.3%
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.5 Use financing secured by accounts receivable or inventory
15) Matt's Machine Company has borrowed $10 million for four months at 5.5% APR, using inventory
stored in a field warehouse as collateral. The warehouse fee is 0.5%, payable at the beginning of the
loan. What is Matt's EAR?
A) 5.50%
B) 7.24%
C) 0.58%
D) 7.01%
E) 3.46%
Answer: B
Explanation: B) Using a financial calculator: PV = $10,000,000, I = 5.5/12 = 0.4583, N = 4;
compute FV = $10,184,598; amount received = $10,000,000 - $50,000 = $9,950,000;
actual rate = 10,184,598 / 9,950,000 = 1.0236; 1.02363 - 1 = .0724 EAR = 7.24%
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.5 Use financing secured by accounts receivable or inventory

16) Matt's Machine Company has borrowed $10 million for four months at 5.5% APR, using inventory
stored in a field warehouse as collateral. The warehouse fee is 0.5%, payable at the end of the loan. What
is Matt's EAR?
A) 5.5%
B) 7.20%
C) 0.58%
D) 7.01%
E) 3.46%
Answer: B
Explanation: B) Using a financial calculator: PV = $10,000,000, I = 5.5/12 = 0.4583, N = 4;
compute FV = $10,184,597; add warehouse fee = $50,000; amount received = $10,000,000;
actual rate = 10,234,597 / 10,000,000 = 1.02346; 1.023463 - 1 = .0720; EAR = 7.20%
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.5 Use financing secured by accounts receivable or inventory

17) ToysToysToys Corporation wants to borrow $500,000 for one month. It uses its inventory as
collateral for a 16% (APR) loan, under a warehouse arrangement where the warehouse fee is $14,000,
paid at the end of the month. What is the EAR of this loan for ToysToysToys?
A) 4.1%
B) 15.4%
C) 45.8%
D) 62.6%
E) 27.3%
Answer: D
Explanation: D) Using a financial calculator: PV = $500,000, I = 16/12 = 1.33, N = 1;
compute FV = $506,666.67; add warehouse fee = $520,667;
actual rate = 520667 / 500,000 = 1.0413; EAR = 1.041312 - 1 = 62.6%
Diff: 1 Type: MC
Skill: Analytical
Objective: 20.5 Use financing secured by accounts receivable or inventory
18) What is the difference between a pledging of accounts receivable and a factoring of accounts
receivable?
Answer: In a pledging of accounts receivable agreement, the lender accepts credit accounts as collateral
for a loan. In a factoring of accounts receivable arrangement, the firm sells receivables to the lender, and
the lender agrees to pay the firm the amount due from its customers.
Diff: 1 Type: SA
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

19) Why does a floating lien agreement have a higher interest rate than other types of short-term
financing with collateral?
Answer: The floating lien, or blanket lien, agreement exposes the lender to more risk because the value
of the collateral used to secure the loan falls as inventory is sold. When a firm becomes financially
distressed, the loan may become under-collateralized. To counter this risk, this type of loan bears a
higher interest rate than other types of secured short-term financing.
Diff: 1 Type: SA
Skill: Conceptual
Objective: 20.5 Use financing secured by accounts receivable or inventory

20.6 Putting It All Together: Creating a Short-Term Financial Plan

1) A short-term financial plan tracks a firm's cash balance and new and existing short-term financing,
enabling managers to forecast shortfalls and plan to fund them in the least costly manner.
Answer: TRUE
Diff: 1 Type: TF
Skill: Conceptual
Objective: 20.6 Know how to create a short-term financial plan