Effective annual interest = (1.002)12 - 1 = 2.43 percent
AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 18-3
Section: 18.5
Topic: Rate on unused line of credit
93. New Town Bank offers you a $40,000 line of credit with an interest rate of 1.85 percent per quarter. The loan agreement also requires that 3 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Short-term investments are currently paying 1.1 percent per quarter. What is the effective annual interest rate on the line of credit if you borrow the entire $40,000 for one year? Assume any funds borrowed or invested use compound interest.
A. 4.47 percent
B. 4.58 percent
C. 7.61 percent
D. 7.78 percent
E. 12.33 percent
Effective annual interest = (1.0185)4 - 1 = 7.61 percent
AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 18-3
Section: 18.5
Topic: Short-term borrowing
94. Josie's Craft Shack has a beginning cash balance for the quarter of $1,126. The store has a policy of maintaining a minimum cash balance of $1,000 and is willing to borrow funds as needed to maintain that balance. Currently, the firm has a loan balance of $480. How much will the store borrow or repay if the net cash flow for the quarter is -$280?
A. $0
B. $28
C. $126
D. $154
E. $280
Cash deficit = $1,126 - $280 - $1,000 = -$154
The firm needs to borrow $154.
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
Learning Objective: 18-3
Section: 18.6
Topic: Minimum cash balance
95. The Cement Works has a beginning cash balance for the quarter of $784. Susie, the firm's president, requires that a minimum cash balance of $800 be maintained and requires that borrowing be used to maintain that balance. If funds have been borrowed, then she requires that those loans be repaid as soon as excess funds are available. Currently, the firm has a loan outstanding of $1,260. How much will the firm borrow or repay this quarter if the quarterly receipts are $3,918 and the quarterly disbursements are $3,774?
A. borrow $16
B. borrow $128
C. borrow $144
D. repay $128
E. repay $144
Cash surplus = $784 + $3,918 - $3,774 - $800 = $128.
The firm will repay $128 this quarter.
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
Learning Objective: 18-3
Section: 18.6
Topic: Short-term financial plan
96. At the beginning of the year, you have an outstanding short-term loan of $274 which was used to cover your cash needs for the previous year. The interest expense for the year is $19. The projected net cash flow for this year is $123, prior to any payment of principal or interest on this loan. What is your anticipated loan balance at year end?
A. $151
B. $170
C. $176
D. $189
E. $193
Loan balance = $274 + $19 - $123 = $170
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
Learning Objective: 18-3
Section: 18.6
Topic: Short-term financial plan
Essay Questions
97. List and describe the three basic types of secured inventory loans. Compare the advantages and disadvantages of these loans.
The three types are blanket lien, trust receipts, and field warehouse financing. The blanket lien is certainly the easiest for the firm since the lender places a lien on the firm's entire inventory. Generally, the borrower does not have to provide any details on the inventory items. Trust receipt financing requires the borrower and lender to specify the exact inventory item which secures each advance. This can be a time-consuming and cumbersome type of financing for the firm. Field warehouse financing requires that an independent company supervise the collateral for the lender. This, too, can be a cumbersome type of financing.
Feedback: Refer to section 18.5
AACSB: Reflective thinking
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 18-3
Section: 18.5
Topic: Secured inventory loans
98. Using two separate graphs, illustrate a flexible and a restrictive short-term financing policy. Place costs on the vertical axis and current assets on the horizontal axis. On each graph, indicate the shortage costs, carrying costs, total costs, and indicate the optimal investment in current assets.
Students should replicate graphs A and B in Figure 18.2 in the text.
Feedback: Refer to section 18.3
AACSB: Reflective thinking
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 18-2
Section: 18.3
Topic: Financing policies
99. Assume that long-term interest rates are substantially higher than short-term interest rates and are expected to remain that way for the foreseeable future. How does this affect a firm's selection of a financing policy for its current assets?
In this situation, firms will tend to prefer short-term debt over long-term debt and thus will tend to opt for a restrictive financing policy.
Feedback: Refer to section 18.3
AACSB: Reflective thinking
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 18-2
Section: 18.3
Topic: Financing policies
100. Compensating balances are frequently a part of revolving lending arrangements with banks, yet they add to the cost of financing for the borrower. Why, then, would borrowers agree to such terms? What other types of alternative financing are available?
Revolvers are flexible lending arrangements which make it convenient for firms to borrow funds on short notice for short periods of time. This is particularly applicable to firms that adhere to a restrictive financing policy. Furthermore, since the compensating balance is typically required only if the borrower draws on the line, the cost is incurred only while loans are outstanding. Alternative types of financing include letters of credit, accounts receivable financing, inventory loans, commercial paper, and trade credit.
Feedback: Refer to section 18.4
AACSB: Reflective thinking
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 18-3
Section: 18.4
Topic: Compensating balances
Multiple Choice Questions
101. Details Corp. has a book net worth of $8,150. Long-term debt is $1,650. Net working capital, other than cash, is $2,150. Fixed assets are $2,000. How much cash does the company have?
A. $4,250
B. $4,550
C. $5,150
D. $5,650
E. $6,750
Cash = $8,150 + $1,650 - $2,150 - $2,000 = $5,650
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-2
Learning Objective: 18-3
Section: 18.1
Topic: Cash equation
102. The Wake-Up Coffee Company has projected the following quarterly sales amounts for the coming year:
Accounts receivable at the beginning of the year are $200. Wake-Up has a 60-day collection period. What is the amount of the accounts receivable balance at the end of Quarter 3?
A. $375
B. $450
C. $500
D. $600
E. $700
A/R Q3 end = (60/90) ´ $750 = $500
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-5
Learning Objective: 18-3
Section: 18.3
Topic: Accounts receivable balance
103. Consider the following financial statement information for the Bulldog Icers Corporation:
How long is the cash cycle?
A. 36.6 days
B. 37.2 days
C. 41.0 days
D. 41.4 days
E. 42.8 days
Inventory turnover = $58,638/[($9,338 + $11,442)/2] = 5.6437 times
Inventory period = 365/5.6437 = 64.67 days
Receivables turnover = $91,544/[($5,670 + $6,947)/2] = 14.5112 times
Receivables period = 365/14.5112 = 25.15 days
Payables turnover = $58,638/[($7,689 + $9,421)/2] = 6.8542 times
Payables period = 365/6.8542 = 53.25 days
Cash cycle = 64.67 + 25.15 - 53.25 = 36.6 days
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-6
Learning Objective: 18-1
Section: 18.2
Topic: Cash cycle
104. Your firm has an average collection period of 42 days. Current practice is to factor all receivables immediately at a 4 percent discount. Assume that default is extremely unlikely. What is the effective cost of borrowing?
A. 28.79 percent
B. 36.20 percent
C. 37.78 percent
D. 40.97 percent
E. 42.58 percent
Number of periods = 365/42 = 8.6905
EAR = {1 + [0.04/(1 - 0.04)]8.6905 - 1 = 42.58 percent
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-7
Learning Objective: 18-3
Section: 18.5
Topic: Factoring receivables
105. Workout Together has projected the following sales for the coming year:
Sales in the year following this one are projected to be 18 percent greater in each quarter. Assume the firm places orders during each quarter equal to 29 percent of projected sales for the next quarter. How much will the firm pay to its suppliers in Quarter 2 if its accounts payable period is 60 days?
A. $212.67
B. $224.33
C. $241.67
D. $251.33
E. $256.67
Q2 payments = (60/90) ´ 0.29 ´ $800 + (30/90) ´ 0.29 ´ $900 = $241.67
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-8
Learning Objective: 18-3
Section: 18.4
Topic: Payments
106. The Thunder Dan's Corporation's purchases from suppliers in a quarter are equal to 65 percent of the next quarter's forecasted sales. The payables period is 60 days. Wages, taxes, and other expenses are 16 percent of sales, and interest and dividends are $60 per quarter. No capital expenditures are planned. Sales for the first quarter of the following year are projected at $720. The projected quarterly sales are:
What is the amount of the total disbursements for Quarter 2?
A. $564.27
B. $579.43
C. $582.15
D. $585.30
E. $590.67
Payment of accounts = (60/90) ´ 0.65 ´ $660 + (30/90) ´ 0.65 ´ $590 = $413.83
Total disbursements = $413.83 + (0.16 ´ $660) + $60 = $579.43
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-9
Learning Objective: 18-3
Section: 18.4
Topic: Payments
107. The following is the sales budget for Duck-n-Run, Inc., for the first quarter of 2009:
The accounts receivable balance at the end of the previous quarter was $45,000 ($32,000 of which was uncollected December sales.) What is the amount of the January collections?
A. $112,400.00
B. $112,408.16
C. $115,703.03
D. $122,356.33
E. $125,400.00
January collections = 0.67 ´ $120,000 + (0.23/0.33) ´ $32,000 + $45,000 - $32,000 = $115,703.03
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-10
Learning Objective: 18-3
Section: 18.4
Topic: Cash collections
108. Here are some important figures from the budget of Nashville Nougats, Inc., for the second quarter of 2009:
The company predicts that 3 percent of its credit sales will never be collected, 36 percent of its sales will be collected in the month of sale, and the remaining 61 percent will be collected in the following month. Credit purchases will be paid in the month following the purchase.
In March 2009, credit sales were $302,400, and credit purchases were $224,640. The April 1 cash balance was $403,200. What is the cash balance at the end of May?
A. $348,887
B. $366,846
C. $414,141
D. $457,777
E. $477,374
April cash balance = $403,200 + (0.36 ´ $547,200) + (0.61 ´ $302,400) - $224,640 - $57,240 - $16,410 - $119,520 = $366,846
May cash balance = $366,846 + (0.36 ´ $570,240) + (0.61 ´ $547,200) - $211,680 - $69,420 - $16,410 - $131,040 = $477,374
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-11
Learning Objective: 18-3
Section: 18.4
Topic: Cash budget
109. You've worked out a line of credit arrangement that allows you to borrow up to $50 million at any time. The interest rate is 0.5 percent per month. In addition, 5 percent of the amount that you borrow must be deposited in a non-interest bearing account. Assume your bank uses compound interest on its line of credit loans. What is the effective annual interest rate on this lending arrangement?
A. 6.50 percent
B. 6.62 percent
C. 6.81 percent
D. 6.87 percent
E. 6.94 percent
Monthly interest = $50,000,000 (0.005) = $250,000
Amount received = (1 - 0.05) $50,000,000 = $47,500,000
Periodic interest = $250,000/$47,500,000 = 0.005263
EAR = (1 + 0.005263)12 - 1 = 6.50 percent
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-13
Learning Objective: 18-3
Section: 18.5
Topic: Cost of borrowing
110. A bank offers your firm a revolving credit arrangement for up to $115 million at an interest rate of 2 percent per quarter. The bank also requires you to maintain a compensating balance of 5 percent against the unused portion of the credit line, to be deposited in a non-interest-bearing account. Assume you have a short-term investment account at the bank that pays 1.3 percent per quarter, and assume the bank uses compound interest on its revolving credit loans. What is the effective annual interest rate on the revolving credit arrangement if your firm does not borrow any money during the year?
A. 0 percent
B. 5.0 percent
C. 5.2 percent
D. 5.3 percent
E. 5.5 percent
EAR = (1 + 0.013)4 - 1 = 5.30 percent
AACSB: Analytic
Bloom's: Application
Difficulty: Basic
EOC #: 18-14
Learning Objective: 18-3
Section: 18.5
Topic: Cost of borrowing
Chapter 19 Cash and Liquidity Management Answer Key
Multiple Choice Questions
1. Yesterday, the president of RB Enterprises received a phone call from DLK, a competitor. DLK is a sole proprietorship. An unexpected family situation has caused the owner to suddenly want to retire and relocate closer to his family. Thus, the assets of DLK are being offered to RB Enterprises at a bargain basement price. While RB Enterprises had not anticipated purchasing these assets, it was decided that the opportunity was too good to pass up. This illustrates which of the following needs to hold cash?
A. precautionary
B. transaction
C. speculative
D. compensation
E. float
Refer to section 19.1
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-1
Section: 19.1
Topic: Speculative motive
2. GT Motors regularly issues short-term debt to finance its daily operations. Suddenly, the credit markets froze and no funds were available for borrowing. Fortunately, the firm had some cash reserves saved that it was able to use to fund its operations until additional credit was available. The need to retain cash for situations such as this is referred to as which one of the following motives for holding cash?
A. speculative
B. float
C. compensating
D. precautionary
E. transaction
Refer to section 19.1
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.1
Topic: Precautionary motive
3. The cash found in a cash drawer that a check-out clerk uses to make change is an example of which of the following motives for holding cash?
A. speculative
B. daily float
C. compensating balance
D. precautionary
E. transaction
Refer to section 19.1
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.1
Topic: Transaction motive
4. Float is defined as the:
A. amount of cash a firm can immediately withdraw from its bank account.
B. difference between book cash and bank cash.
C. change in a firm's cash balance from one accounting period to the next.
D. amount of cash a firm has on hand.
E. cash balance according to a firm's records.
Refer to section 19.2
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.2
Topic: Float
5. A lockbox is a:
A. special safe used by a firm for overnight storage of any cash or undeposited checks.
B. special safe used by a firm that can only be opened at prespecified times of the day.
C. box located in a bank's vault that is rented by a firm and used to hold unprocessed checks.
D. special post office box which can only be opened by prespecified postal inspectors for direct delivery to the addressee.
E. post office box strategically located so that a firm's receivables can be collected faster.
Refer to section 19.3
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Lockbox
6. The Presque Isle Center has branch operations in three states. Each branch deals with a local bank. However, all excess funds in these branch bank accounts are transferred on a daily basis to the firm's primary bank located near the firm's home office. This routine of transferring cash to the primary bank on a regular basis is referred to as:
A. cash concentration.
B. strategic cash disbursement.
C. transfer flotation.
D. payables management.
E. float management.
Refer to section 19.3
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Cash concentration
7. An account into which funds are deposited only in an amount equal to the value of the checks presented for payment that day is called a _____ account.
A. lockbox
B. concentration
C. zero-balance
D. compensating balance
E. revolving
Refer to section 19.4
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.4
Topic: Zero-balance accounts
8. An account into which a firm transfers funds, usually from a master account, in an amount sufficient to cover the checks presented for payment that day is called a _____ account.
A. lockbox
B. cleanup
C. compensating balance
D. revolving
E. controlled disbursement
Refer to section 19.4
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.4
Topic: Controlled disbursement account
9. The Snow Hut has analyzed the carrying and shortage costs associated with its cash holdings and determined that the firm should ideally maintain a cash balance of $3,600. This $3,600 represents which one of the following to the firm?
A. target cash balance
B. concentration balance
C. available balance
D. selected cash amount
E. compensating balance
Refer to section 19.A
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-3
Section: 19.A
Topic: Target cash balance
10. Adjustment costs is another name for which one of the following?
A. borrowing costs
B. shortage costs
C. cash transfer costs
D. cash wire costs
E. excess cash costs
Refer to section 19.A
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-3
Section: 19.A
Topic: Adjustment costs
11. Why do firms need liquidity?
I. to meet compensating balance requirements
II. to take advantage of an opportunity that suddenly arises
III. to conduct daily business activities
IV. to be prepared for a financial emergency
A. I and II only
B. III and IV only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV
Refer to section 19.1
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.1
Topic: Motives for liquidity
12. Cash management primarily involves:
A. optimizing a firm's collections and disbursements of cash.
B. maximizing the income a firm earns on its cash reserves.
C. reconciling a firm's book balance with its bank balance.
D. determining the optimal level of liquidity a firm should maintain.
E. determining the best method of raising capital.
Refer to section 19.1
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.1
Topic: Cash management
13. Disbursements float:
A. occurs when a deposit is recorded but the funds are unavailable.
B. causes the book balance to exceed the bank balance.
C. has tended to increase since the enactment of the Check Clearing Act for the 21st Century.
D. is a recommended source of funds for short-term investments.
E. is eliminated when payments are made electronically.
Refer to section 19.2
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-1
Section: 19.2
Topic: Disbursement float
14. Collection float:
A. is more desirable to firms than disbursement float.
B. is totally eliminated by the installation of a lockbox system.
C. exists when a firm's available balance exceeds its book balance.
D. can be avoided by collecting payments electronically at the time of sale.
E. is eliminated by implementing a concentration banking system.
Refer to section 19.2
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-1
Section: 19.2
Topic: Collection float
15. Which one of the following statements is correct?
A. Net float decreases every time a firm issues a check to pay one of its suppliers.
B. A positive net float indicates that collection float exceeds disbursements float.
C. Firms prefer a zero net float over a positive net float.
D. Net float is equal to collection float minus disbursement float.
E. Net float is equal to a firm's available balance minus its book balance.
Refer to section 19.2
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.2
Topic: Net float
16. Check kiting is:
A. used by most firms as an ethical means of handling its cash reserves.
B. the process of withdrawing all funds from a bank account as soon as the funds are available.
C. the central core of a good cash management system.
D. using uncollected cash to invest in short-term, liquid assets.
E. increasingly popular due to recent banking law changes.
Refer to section 19.2
AACSB: Ethics
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-1
Section: 19.2
Topic: Ethical issue
17. Which of the following will reduce collection time?
I. billing customers electronically rather than by mail
II. accepting debit cards but not checks as payment for a sale
III. offering cash discounts for early payment
IV. reducing the processing delay by one day
A. I and II only
B. I and III only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
Refer to section 19.3
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Collection time
18. Which of the following should help reduce the total collection time for a firm?
I. opening a post office box so mail can be received earlier in the morning
II. assigning additional staff in the morning to process incoming payments
III. providing a discount for customers who pay electronically
IV. establishing preauthorized payments from customers
A. I and II only
B. III and IV only
C. II, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV
Refer to section 19.3
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Collection time
19. Which one of the following collection times is correctly described?
A. The processing delay starts when a firm mails out a billing statement and ends when the payment is received from a customer.
B. Mailing time begins when a firm mails out a billing statement and ends when the payment is received.
C. Collection time begins when a firm mails out a billing statement and ends when the cash payment for that billing is available to the firm.
D. Availability delay begins when a firm deposits a customer's check into its bank account and ends when the cash from that payment is available to the firm.
E. Processing delay begins when a firm mails out billing statements and ends when the firm deposits the payment for that statement into its bank account.
Refer to section 19.3
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Collection time
20. A lockbox system:
A. entails the use of a bank which is centrally located to collect payments on a nationwide basis.
B. is designed to deposit a customer's check into the firm's bank account prior to recording the receipt of that check to a customer's account.
C. is used to reduce the disbursement float of a firm.
D. is efficient regardless of the locations selected for lockbox destinations.
E. automatically records payments to a customer's account when the customer's check is received at the lockbox location.
Refer to section 19.3
AACSB: N/A
Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Lockbox
21. Lockboxes:
A. should be geographically located close to a firm's primary customers.
B. should be located in remote locations to increase the net disbursement float.
C. offer no additional benefit to a firm now that the Check Clearing Act for the 21st Century has been enacted.
D. tend to be negative net present value projects for firms with a large number of sizeable transactions.
E. tend to also be used as concentration accounts.
Refer to section 19.3
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 19-2
Section: 19.3
Topic: Lockbox
22. Cash concentration accounts:
A. tend to increase the funds available for short-term investing.
B. tend to increase the complexity of a firm's cash management system.
C. that utilize wire transfers rather than automated clearing house transfers are less expensive to maintain.
D. receive checks directly from all of a firm's customers.
E. are all zero-balance accounts.
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