Question 1

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?

Accepted Answer

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 is known as a single, end-of-period payment loan. This type of loan is different from an installment loan where the firm repays the loan in multiple payments over time.

Question 2

Ahab's Army Surplus has a committed 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?

Accepted Answer

The answer of Ahab's Army Surplus has a committed line...

Question 3

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?

Accepted Answer

An uncommitted line of credit is an informal agreement where a bank agrees to lend a firm any amount up to a stated maximum, but is not legally bound to provide the funds. This type of loan arrangement is typically used for short-term and temporary financing needs, such as funding seasonal inventory buildup. It is also sometimes referred to as a demand loan or a handshake loan. The other options listed (single, end-of-period payment loan, bridge loan, committed line of credit, and revolving line of credit) all involve different types of loan arrangements with different characteristics.

Question 4

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?

Accepted Answer

A committed line of credit arrangement typically requires the borrowing firm to maintain a minimum balance with the lending bank, known as compensating balances, and may also restrict the level of the firm's working capital. The other loan arrangements mentioned, such as a single end-of-period payment loan or a discount loan, do not typically come with such requirements. A bridge loan is a short-term loan used to bridge a financing gap until longer-term financing can be arranged, while uncommitted lines of credit do not require the borrower to use the credit facility but may come with higher interest rates or fees.

Question 5

Bandolier Bicycles has a committed 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?

Accepted Answer

The total cost of the loan is the interest expense plus the commitment fee. The interest expense is $375,000 * 4% = $15,000. The commitment fee is $450,000 * 0.3% = $1,350. Therefore, the total cost of the loan is $15,000 + $1,350 = $16,350.

Question 6

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?

Accepted Answer

The answer of If the benefit of a lower rate...

Question 7

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?

Accepted Answer

First we need to calculate the loan origination fee:
Loan origination fee = $300,000 x 1% = $3,000
Next, we need to calculate the effective interest rate (EAR):
EAR = (1 + APR/n)^n - 1
where APR is the annual percentage rate, n is the number of times the interest is compounded in a year.
Here, APR = 6%, n = 1
EAR = (1 + 6%/1)^1 - 1 = 6.17%
Finally, we need to adjust the EAR for the loan origination fee using the following formula:
Adjusted EAR = [(1 + EAR)/(1 - Loan origination fee)] - 1
Adjusted EAR = [(1 + 6.17%)/(1 - 1%)] - 1 = 7.07%
Therefore, the actual interest rate paid is 7.07%, which is closest to option C (7.07%).

Question 8

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?

Accepted Answer

The actual three-month interest paid can be calculated by first determining the effective interest rate on the loan, taking into account the required compensating balance. The loan amount is $4,000,000, and the bank requires 10% of this amount, or $400,000, to be kept in an account. This reduces the effective loan amount to $3,600,000. The interest for three months at an APR of 6% on $4,000,000 is $60,000. However, the compensating balance earns interest at an APR of 2%, which for three months on $400,000 is $2,000. Therefore, the net interest paid is $60,000 - $2,000 = $58,000. To find the actual interest rate paid over the three months, divide the net interest by the effective loan amount: $58,000 / $3,600,000 = 0.0161 or 1.61%. Since this is a three-month rate, to annualize it, you multiply by 4 (to account for four three-month periods in a year), resulting in an APR of approximately 6.44%. This calculation simplifies the process by not compounding the interest, which is a reasonable approximation for short-term loans. The closest answer provided is 6.6%.

Question 9

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?

Accepted Answer

First, we need to calculate the dollar amount that needs to be kept in the non-interest-earning account: 
12% of $1,000,000 = $120,000

Next, we need to calculate the interest paid on the remaining $880,000: 
I = P x R x T 
I = $880,000 x 0.08 x (3/12) = $17,600

Finally, we need to calculate the effective annual rate (EAR) using the following formula: 
EAR = (1 + APR/n)^n - 1 
EAR = (1 + 0.08/4)^4 - 1 = 0.0941 or 9.41%

Therefore, the actual three-month interest rate paid, expressed as an EAR, is 9.41%.

Question 10

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?

Accepted Answer

The answer of Strata Services has a three month $450,000...

Question 11

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

Accepted Answer

Evergreen credit is a committed line of credit that has no fixed maturity date. This means that the borrower can continuously borrow and repay funds without having to constantly renew the loan. A bridge loan is a short-term financing option, a promissory note is a written promise to repay a loan, a blanket lien is a security interest in multiple assets, and a discount loan is a loan where the interest is deducted upfront. None of these options specifically relate to a committed line of credit with no fixed maturity.

Question 12

Katie's Karate Dojo has a committed 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?

Accepted Answer

The commitment fee is 0.5% of $300,000, which is $1,500 (EAR).

The interest expense is 6% of $300,000, which is $18,000 (EAR).

Therefore, the total cost of the loan is $1,500 + $18,000 = $19,500 (EAR).

Note: The question specifies that the interest rate is EAR (effective annual rate), so we need to use EAR to calculate the costs.

Question 13

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?

Accepted Answer

The actual amount borrowed by Jim's Electrical is $400,000 - (5% of $400,000) = $380,000.
The interest paid for six months at an APR of 9% is:
$380,000 x 9% x (6/12) = $17,100
To find the EAR, we use the formula:
EAR = (1 + (APR/m))^m - 1
where m is the number of compounding periods in one year.
Since the loan is for six months, there will be two compounding periods in one year.
EAR = (1 + (0.09/2))^2 - 1 = 0.097 = 9.70%
Therefore, the actual six-month interest rate paid, expressed as an EAR, is 9.70%.

Question 14

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?

Accepted Answer

The actual interest rate paid can be calculated by considering both the interest on the loan and the loan origination fee. The interest for one year is 5% of $2 million, which is $100,000. The loan origination fee is 2% of $2 million, which is $40,000. Therefore, the total cost of the loan is $140,000 ($100,000 + $40,000). To find the actual interest rate paid, divide the total cost of the loan by the loan amount and then multiply by 100 to convert to a percentage: ($140,000 / $2,000,000) * 100 = 7%. However, this calculation does not account for the fact that the origination fee reduces the actual amount of money available from the loan. The effective interest rate considering the reduced loan amount due to the upfront fee is higher, which is correctly calculated as 7.14% when considering the effective annual rate formula and the impact of upfront fees on the available loan amount.

Question 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?

Accepted Answer

The effective annual rate (EAR) accounts for the compounding effect and fees. The loan origination fee effectively reduces the amount available to the borrower, increasing the effective interest rate. The EAR can be calculated using the formula: EAR = (1 + (APR/n))^n - 1, where n is the number of compounding periods. Adjusting for the origination fee, the EAR is approximately 9.02%.

Question 16

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

Accepted Answer

An uncommitted line of credit is not a binding agreement and is often informal, meaning that the lender can choose to not lend funds at any time.

Question 17

The prime rate is the rate banks charge all but their largest customers,who can negotiate a sub-prime rate.

Accepted Answer

The prime rate is the interest rate that commercial banks charge their most creditworthy customers, typically large corporations. There is no "sub-prime rate" for larger customers; rather, subprime refers to loans offered at rates above the prime rate to borrowers with poor credit.

Question 18

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?

Accepted Answer

The answer of Gemini Real Estate is offered a $2...

Question 19

How can a conservative financing policy reduce firm value?

Accepted Answer

The answer of How can a conservative financing policy reduce...

Question 20

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?

Accepted Answer

The company has taken a bridge loan, which is a short-term loan taken by a borrower until they can secure long-term financing. In this case, the company needs the funds quickly to purchase the vibroseis shakers and plans to obtain long-term financing later.

Quiz 20: Short-Term Financial Planning

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?

Ahab's Army Surplus has a committed 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?