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Exam 17: Working Capital Management and Short-Term Financing

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Question 21

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Which of the following statements best describes short-term versus long-term financing?

A) Flexibility is an advantage of short-term credit, but this is somewhat offset by the high flotation costs associated with the need to repeatedly renew short-term credit.
B) A short-term loan can usually be obtained more quickly than a long-term loan, but the penalty for early repayment of a short-term loan is normally significantly higher than that for a long-term loan.
C) The flexibility, cost, and riskiness of short-term versus long-term credit are dependent on the type of credit that is actually used.
D) Short-term debt is often less costly than long-term debt, and the major reason for this is that short-term debt exposes the borrowing firm to much less risk than long-term debt.

E) B) and D)
F) B) and C)

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Question 22

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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.

A) True
B) False

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Question 23

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Margetis Inc. carries an average inventory of $1,000,000. Its annual sales are $10 million, and its receivables conversion period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $863,000 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day reduction in the cash conversion cycle?

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

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

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.

Which of the following statements is INCORRECT?

Which of the following borrowers benefit the most from a revolving line of credit?

Hefner Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual rate of funds raised by this action? (Assume a 365-day year.)

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

Pledging of receivables involves the sale of accounts receivable.

Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1) when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health, and (2) long-term loan agreements are more complex.

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.

Your firm needs $630 for one quarter to finance a deficit. Interest charges are 2% per quarter. Your bank requires a 10% compensating balance. How much must your firm borrow in order to obtain the needed funds?

If a firm takes actions that reduce its DSO, then, other things held constant, this will lengthen its CCC.

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.

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

Which of the following statements best describes cash budgets?

Offering trade credit discounts is costly and, as a result, firms that offer trade discounts are usually those that are performing poorly and need cash quickly.

Which of the following statements best describes compensating balances?