Chapter 6 - Seatwork

True or False
1. The use of short-term debt provides flexibility in financing since the firm is only paying interest when it is using the
borrowed funds.
2. A firm can reduce net working capital by substituting long-term financing, such as bonds, with short-term financing,
such as one-year notes payable.
3. Notes payable is a spontaneous source of financing.
4. Increasing the use of short-term debt versus long-term debt financing will increase profit.
5. Current liabilities have greater liquidity risk due to the higher frequency that they have to be repaid or rolled over.
6. Trade credit is a source of spontaneous financing.
7. Short-term debt is frequently less expensive because it provides the borrower more security.
8. Sources of financing repaid in six months to one year are usually categorized as long-term.
9. Major sources of secured credit include commercial banks, finance companies, and factors.
10. Inventory loans are considered an unsecured source of financing.
11. The cost of trade credit varies directly with the size of the cash discount and inversely with the length of time between
the end of the discount period and the final due date.
12. The continual practice of stretching on trade credit is potentially a very useful source of short-term credit for the firm.
13. The effective cost to the borrower of an unsecured bank loan is increased if a compensating balance is required.
14. Minimizing working capital is accomplished by slowing down the cash conversion cycle.
15. The conventional method for financing permanent levels of accounts receivable and inventory is accounts payable and
accrued expenses.
16. A firm should take the cash discount if the firm’s cost of borrowing from the bank is greater than the cost of giving up
a cash discount.
17. If a firm anticipates stretching accounts payable, its cost of giving up a cash discount is reduced.
18. The cost of giving up a cash discount on a credit purchase is the implied interest rate paid in order to delay payment
for an additional number of days.
19. In giving up a cash discount, the amount of the discount that is given up is the interest being paid by a firm to keep its
money by delaying payment for a number of days.
20. A revolving credit agreement is a form of financing consisting of short-term, unsecured promissory notes issued by
firms with a high credit standing.
Multiple Choices
1. Which of the following is spontaneous source of financing?
a. Accrued wages c. Trade credit
b. Preferred stock d. Both a and c
2. Accounts receivable and inventory self-liquidate through the _______ cycle.

a. Spontaneous account c. Cash conversion
b. Net working capital d. Sales to receivables collection
3. Which of the following is considered a source of spontaneous financing?

a. Trade credit c. Accounts payable
b. Inventories d. Both a and c
4. With regard to the hedging principle, which of the following assets should be financed with current liabilities?
a. Minimum level of cash required for year-round operations
b. Expansion of accounts receivable to meet seasonal demands
c. Machinery used to produce a firm’s inventory
d. Both a and b
5. Trade credit is an example of which of the following sources of financing?

a. Spontaneous c. Permanent
b. Temporary d. Both a and b
6. Which of the following is a spontaneous source of financing?

a. Accounts payable
b. Accounts payable and wages and salaries payable
c. Accounts payable and inventories
d. Accounts payable, wages and salaries payable, and accrued interest
7. Which of the following types of financing offers the firm the greatest degree of flexibility?
a. Bonds c. Short-term lines of credit
b. Preferred stock d. Long-term notes payable
8. Which of the following actions would improve a firm’s liquidity?
a. Selling stock and reducing accounts payable
b. Selling stock to purchase equipment
c. Selling bonds and purchasing machinery
d. Both a and c
9. As sales increase, a company needs more inventory and more employees resulting in
a. More accounts payable and accruals, and therefore increasing its spontaneous liabilities
b. Less accounts payable and accruals, and therefore decreasing its spontaneous liabilities
c. More accounts payable and accruals, and therefore decreasing its spontaneous liabilities
d. Less accounts payable and accruals, and therefore increasing its spontaneous liabilities
10. A negative cash conversion cycle

a. Means that the operating cycle exceeds the average inventory period
b. Means that the average payment period exceeds the operating cycle
c. Indicates that a firm is shortening its average payment period and lengthening its average collection period
d. Indicates that a firm is shortening its average age of inventory and average payment period
11. If a firm decides to take the cash discount that is offered on goods purchased on credit, the firm should
a. Pay as soon as possible
b. Pay on the last day of the credit period
c. Pay on or before the last day of the discount period
d. Not take the discount no matter when the firm actually pays
12. The effective interest rate generally is

a. Lower if the loan is a discount loan
b. Higher if the loan is a discount loan
c. Higher on a loan if interest is paid at maturity
d. Not affected by whether the loan is a discount loan or a loan with interest paid at maturity
13. The cost of giving up a cash discount on a credit purchase is

a. The true purchase price of the goods
b. Added on to the price of the goods in order to make payment quickly
c. Deducted from the price of the goods in order to make payment quickly
d. The implied interest rate paid in order to delay payment for an additional number of days
14. Short-term loans that businesses obtain from banks and through commercial paper are _______.
a. Negotiated and secured c. Spontaneous and secured
b. Negotiated and unsecured d. Spontaneous and unsecured
15. Short-term, self-liquidating loans are intended to

a. Recapitalize the firm
b. Provide maximum amount to the firm that it can owe to the bank
c. Provide one-time loan to the borrower who needs funds for a specific purpose
d. Cover seasonal peaks in financing caused by inventory and receivable build-ups

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True or False

2. Accounts receivable and inventory self-liquidate through the _______ cycle.

3. Which of the following is considered a source of spontaneous financing?

5. Trade credit is an example of which of the following sources of financing?

6. Which of the following is a spontaneous source of financing?

10. A negative cash conversion cycle

12. The effective interest rate generally is

13. The cost of giving up a cash discount on a credit purchase is

15. Short-term, self-liquidating loans are intended to

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