CHAPTER 17

1. Accruals are “free” in the sense that no interest must be paid on these funds.

a. True
b. False

2. The effect of compensating balances is to decrease commercial paper is correct?

a. True
b. False

3. Which of the following statements concerning commercial paper is correct?

a. Commercial paper is secured debt of large, financial strong firms

b. Maturities of commercial paper generally exceed nine months
c. Commercial paper interest rates are typically 1.25 to 1.50 percentage points above the
stated prime rate.
d. None of the above statements is correct.

4. A firm buys on terms of 2/10. net of 30, but generally does not pay until 40 days after the
invoice date. Its purchases total P1,080,000 per year. How much "non-free" trade credit does
the firm use on average each year?

a. P120,000
b. P90,000
c. P60,000
d. P30,000

5. Refer to item no 4. What is approximate cost of the "non-free" trade credit?

a. 16.2%
b. 19.4%
c. 21.9%
d. 24.5%

6. Gees Pipelines, Inc., has developed plans for new pump that will allow more economical
operation of the company’s oil pipelines. Management estimates that P2,400,000 will be
required to put this new pump into operation. Fund can be obtained from a bank at 10%
discount interest, or the company can finance the expansion by delaying payment to its
suppliers. Presently, Gees purchases under terms of 2/10, net 40, but management believes
payment could be delayed 30 additional days without penalty; that is, payment could be made in
70 days. Which means financing should Gees use? (Use approximate cost of trade credit)

a. Trade credit, since the cost is about 12.24%.

b. Trade credit, since the cost is about 3.13% points less than the bank loan
c. Bank loan, since the cost is about 1.13% points less than trade credit
d. Bank loan, since the cost is about 3.13% points less that trade credit
The following data apply to 7-10:

You plan to borrow P10,000 from your bank, which offers to lend you the money at a10%
nominal, or stated rate on a 1-year loan.

7. What is the effective interest rate if the loan is a discount loan?

a. 11.1%
b. 13.3%
c. 15%
d. 20%

8. What is the approximate effective interest rate if the loan is an add-on interest loan with 12
monthly payments?

a. 11.1%
b. 13.3%
c. 15%
d. 20%

9. What is the effective interest rate if the loan is a discount loan with a 15% compensating
balance?

a. 11.1%
b. 13.3%
c. 15%
d. 20%

10. Under the terms of question no. 9, how much would you have to borrow to have the use of
P10,000?

a. P10,000
b. P11,111
c. P12,000
d. P13,333

Answers

1. A 6. C

2. B 7. A

3. D 8. D

4. B 9. B

5. D 10. D