Question 1

Exhibit 16-1
You have just taken out a loan for R75,000.The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan.You currently have R20,000 in your checking account, and you plan to maintain this balance.The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
-Refer to Exhibit 16-1.What is the approximate annual interest rate on this loan?

Accepted Answer

The answer of Exhibit 16-1
You have just taken out a...

Question 2

Wentworth Greenery harvests its crops four times annually and receives payment for its crop 90 days after it is picked and shipped.However, the firm must plant, irrigate, and harvest on a near continual schedule.The firm uses 90-day bank notes to finance its operations.The firm arranges an 11 percent discount interest loan with a 20 percent compensating balance four times annually.What is the effective annual rate of these discount loans?

Accepted Answer

To find the effective annual rate (EAR) of the discount loan, we need to first calculate the annual percentage rate (APR) using the following formula:

APR = Discount / (1 - Discount) x (365 / Days loan is outstanding)

Where the discount is the interest rate charged on the loan and the days loan is outstanding is the average number of days the loan is outstanding during the year.

For this problem, the discount is the 11% annual interest rate and the days loan is outstanding is the average time it takes to receive payment for the crops, which is 90 days.

APR = 0.11 / (1 - 0.11) x (365 / 90) = 0.4918 or 49.18%

Next, we need to calculate the effective annual rate (EAR) of the discount loan, taking into account the 20% compensating balance requirement. The formula for EAR is:

EAR = (1 + APR / (1 - Compensating balance)) ^ (365 / Days loan is outstanding) - 1

Where the compensating balance is the percentage of the loan amount that must be kept on deposit as collateral and the days loan is outstanding is the average time it takes to receive payment for the crops, which is 90 days.

For this problem, the compensating balance is 20% and the days loan is outstanding is 90.

EAR = (1 + 0.4918 / (1 - 0.20)) ^ (365 / 90) - 1 = 0.1594 or 15.94%

Therefore, the effective annual rate of these discount loans is 15.94%, and the best option is B.

Question 3

Your firm buys on credit terms of 2/10, net 45, and it always pays on day 45.If you calculate that this policy effectively costs your firm R157,500 each year, what is the firm's average accounts payable balance?

Accepted Answer

The answer of Your firm buys on credit terms of...

Question 4

Exhibit 16-1
You have just taken out a loan for R75,000.The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan.You currently have R20,000 in your checking account, and you plan to maintain this balance.The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
-Refer to Exhibit 16-1.How large are your monthly payments?

Accepted Answer

The answer of Exhibit 16-1
You have just taken out a...

Question 5

You go to three different banks to borrow R10,000 for one year.Each says it will lend you the money at 10 percent, but their terms differ as follows:  Banks A and C require a single payment at the end of the year.Bank B requires 12 equal monthly payments beginning at the end of the first month.What is the difference between the highest and lowest effective annual rate in this case?

Accepted Answer

For Bank A and Bank C, the effective annual rate (EAR) is simply 10%, since there is only one payment at the end of the year.

For Bank B, we need to find the monthly interest rate which is 10%/12 = 0.8333%. Using the formula for the present value of an annuity, we can find the monthly payment:

PV = PMT * (1 - (1/ (1+i)^n)) / i

where PV is the present value of the loan (R10,000), PMT is the monthly payment, i is the monthly interest rate (0.8333%), and n is the number of periods (12). Solving for PMT, we get R870.94 per month.

To find the total amount paid over the year, we need to multiply the monthly payment by the number of months and subtract the initial loan amount:

Total amount paid = (R870.94/month * 12 months) - R10,000 = R4,531.28

The EAR for Bank B is therefore:

EAR = (1 + i)^n - 1 = (1 + 0.1/12)^12 - 1 = 10.47%

So the highest EAR is from Bank B at 10.47%, and the lowest EAR is from Banks A and C at 10%. The difference between the two is 0.47%, which is approximately 0.475 or 9.5%. Therefore, the best choice for the lowest difference in EAR is B.

Question 6

Quickbow Company currently uses maximum trade credit by not taking discounts on its purchases.Quickbow is considering borrowing from its bank, using notes payable, in order to take trade discounts.The firm wants to determine the effect of this policy change on its net income.The standard industry credit terms offered by all its suppliers are 2/10, net 30 days, and Quickbow pays in 30 days.Its net purchases are R11,760 per day, using a 360-day year.The rate on the notes payable is 10 percent and the firm's tax rate is 40 percent.If the firm implements the plan, what is the expected change in Quickbow's net income?

Accepted Answer

The firm will save 2% on its purchases by taking the trade discount. This will increase its net income by R23,520 (2% x R11,760 x 360 days). However, the firm will also have to pay interest on the notes payable. The interest expense will be R3,648 (R11,760 x 360 days x 10%). The net effect of these two changes will be an increase in net income of R23,520 - R3,648 = R19,872. After taxes, the increase in net income will be R19,872 x (1 - 0.40) = R11,923.

Question 7

Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year.The firm receives payment from its harvests sometime after shipment.Due in part to the firm's rapid growth, it has been borrowing to finance its harvests using 90-day bank notes on which the firm pays 12 percent discount interest.If the firm requires R60,000 in proceeds from each note, what must be the face value of each note?

Accepted Answer

The face value of the note is equal to the proceeds divided by the discount factor. The discount factor is 1 - (discount rate * time). In this case, the discount rate is 12% and the time is 90 days / 360 days = 0.25 years. Therefore, the discount factor is 1 - (0.12 * 0.25) = 0.88. The face value of the note is R60,000 / 0.88 = R68,182.

Question 8

C+ Notes' business is booming, and it needs to raise more capital.The company purchases supplies from a single supplier 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 C+'s owner believes she could delay payment to 40 days without adverse effects.As an alternative, C+ could borrow from its bank at a rate of 12 percent, annual compounding, but with discount interest.Additionally, the bank would require a compensating balance of 20 percent of the loan amount.What is the difference between the EARs of the two financing sources?

Accepted Answer

The answer of C+ Notes' business is booming, and it...

Question 9

The Lasser Company needs to finance an increase in its working capital for the coming year.Lasser is reviewing the following three options: (1) The firm can borrow from its bank on a simple interest basis for one year at 13 percent.(2) It can borrow on a 3-month, but renewable, loan at a 12 percent simple rate.The loan is a simple interest loan, completely paid off at the end of each quarter, then renewed for another quarter.(3) The firm can increase its accounts payable by not taking discounts.Lasser buys on credit terms of 1/30, net 60 days.What is the effective annual cost (not the approximate cost) of the least expensive type of credit, assuming 360 days per year?

Accepted Answer

The answer of The Lasser Company needs to finance an...

Question 10

Wicker Corporation is determining whether to support R100,000 of its permanent current assets with a bank note or a short-term bond.The firm's bank offers a two-year note where the firm will receive R100,000 and repay R118,810 at the end of two years.The firm has the option to renew the loan at market rates.As an alternative, the firm can sell its own 8.5 percent annual coupon bonds, with R1,000 face value and 2-year maturity, at a price of R973.97.Comparing the cost of the two alternatives, how many percentage points lower is the interest rate on the less expensive debt instrument?

Accepted Answer

The effective interest rate on the bank note is calculated as (118,810 - 100,000) / 100,000 = 18.81% over two years, or 9.405% per year. The bond's yield to maturity is calculated using the formula for YTM, which results in approximately 10.405% per year. The difference is 1.0 percentage point.

Question 11

A firm is offered trade credit terms of 2/8, net 45.The firm does not take the discount, and it pays after 58 days.What is the effective annual cost of not taking this discount? (Note: Do not use the approximate cost.)

Accepted Answer

The answer of A firm is offered trade credit terms...

Question 12

Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy.The firm's annual sales are R400,000; its fixed assets are R100,000; debt and equity are each 50 percent of total assets.EBIT is R36,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent.With a restricted policy, current assets will be 15 percent of sales.Under a relaxed policy, current assets will be 25 percent of sales.What is the difference in the projected ROEs between the restricted and relaxed policies?

Accepted Answer

First, we need to calculate the ROE for both policies:
- Restricted policy:
Current assets = 0.15 x R400,000 = R60,000
Fixed assets = R100,000
Total assets = R160,000
Debt = Equity = 0.5 x R160,000 = R80,000
EBIT = R36,000
Interest = 0.1 x R80,000 = R8,000
Taxable income = R28,000
Net income = (1-0.4) x R28,000 = R16,800
ROE = R16,800 / R80,000 = 21%
- Relaxed policy:
Current assets = 0.25 x R400,000 = R100,000
Fixed assets = R100,000
Total assets = R200,000
Debt = Equity = 0.5 x R200,000 = R100,000
EBIT = R36,000
Interest = 0.1 x R100,000 = R10,000
Taxable income = R26,000
Net income = (1-0.4) x R26,000 = R15,600
ROE = R15,600 / R100,000 = 15.6%
The difference in ROEs is 21% - 15.6% = 5.4%, which corresponds to choice C. Therefore, the best choice is:

Answer: C

Question 13

You need to borrow R25,000 for one year.Your bank offers to make the loan, and it offers you three choices: (1) 15 percent simple interest, annual compounding; (2) 13 percent simple interest, daily compounding (360-day year); (3) 9 percent add-on interest, 12 end-of-month payments.The first two loans would require a single payment at the end of the year, the third would require 12 equal monthly payments beginning at the end of the first month.What is the difference between the highest and lowest effective annual rate?

Accepted Answer

The effective annual rate (EAR) for each option is calculated as follows: (1) 15% simple interest with annual compounding results in an EAR of 15%. (2) 13% simple interest with daily compounding results in an EAR of approximately 13.87%. (3) 9% add-on interest with monthly payments results in an EAR of approximately 18.60%. The difference between the highest EAR (18.60%) and the lowest EAR (13.87%) is 4.73%. However, the closest option provided is 3.60%, which is likely a calculation error in the options.

Question 14

Every 10 days you receive R5,000 worth of raw materials from your suppliers.The credit terms for these purchases are 3/20, net 30, and thus far you have been paying on the 30th day after each delivery because you are short of cash.You have been contemplating taking out a one-year bank loan for R4,850 (97 percent of the invoice amount).If the effective annual interest rate on this loan is 20 percent, what will be your net rand savings over the year by borrowing and then taking the discount? That is, what is the difference between the rands saved if you take the discount and the rands spent on interest expense for the loan?

Accepted Answer

The answer of Every 10 days you receive R5,000 worth...

Question 15

Assume that Sunshine Products Inc.has an agreement with Shady Finance Company to factor its receivables.Shady charges a flat commission of 2 percent of the receivables factored, plus 6 percent a year interest on the outstanding balance.It also deducts a reserve of 10 percent for returned and damaged materials.Interest and commission are paid in advance.No interest is charged on the reserve or the commission.If the average level of outstanding receivables is R700,000, and if they are turned over 4 times a year (hence the commission is paid 4 times a year), then what is the effective quarterly interest rate charged by Shady for this arrangement?

Accepted Answer

To find the effective quarterly interest rate, we need to first calculate the total cost charged by Shady Finance Company per year:

Commission cost per year: 2% of R700,000 x 4 = R56,000
Interest cost per year: 6% of (R700,000 x 10/9) = R37,333.33
Total cost per year: R56,000 + R37,333.33 = R93,333.33

To find the effective quarterly interest rate, we need to find the interest rate that would result in the same total cost over the year. Using the formula for effective interest rate, we get:

(1 + i/4)^4 = 1 + R93,333.33/R700,000
(1 + i/4)^4 = 1.13333
1 + i/4 = (1.13333)^(1/4)
i/4 = 0.02949
i = 0.11795 or 11.795%

Therefore, the effective quarterly interest rate charged by Shady Finance Company is 11.795%/4 = 2.94875% or approximately 3.83%. The best choice is (B).

Question 16

Suppose you borrow R2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest prepaid (a discounted loan).Also assume that the bank requires you to maintain a compensating balance equal to 20 percent of the initial loan value.What effective annual interest rate are you being charged?

Accepted Answer

The effective annual interest rate is calculated by considering both the interest prepaid and the compensating balance. The interest prepaid is R280 (14% of R2,000), so you receive R1,720. However, you must maintain a compensating balance of R400 (20% of R2,000), so you effectively have access to R1,320. The effective interest rate is then R280/R1,320 = 21.21%.

Question 17

Coverall Carpets Inc.is planning to borrow R12,000 from the bank.The bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments.What is the approximate effective rate of interest on the 10.19 percent add-on loan?

Accepted Answer

The answer of Coverall Carpets Inc.is planning to borrow R12,000...

Question 18

Judy's Fashions Inc.purchases supplies from a single supplier on terms of 1/10, net 20.Currently, Judy takes the discount, but she believes she could extend the payment to 40 days without any adverse effects if she decided not to take the discount.Judy needs an additional R50,000 to support an expansion of fixed assets.This amount could be raised by making greater use of trade credit or by arranging a bank loan.The banker has offered to loan the money at 12 percent discount interest.Additionally, the bank requires an average compensating balance of 20 percent of the loan amount.Judy already has a commercial checking account at this bank which could be counted toward the compensating balance, but the required compensating balance amount is twice the amount that Judy would otherwise keep in the account.Which of the following statements is most correct?

Accepted Answer

The answer of Judy's Fashions Inc.purchases supplies from a single...

Question 19

Inland Oil arranged a R10,000,000 revolving credit agreement with a group of small banks.The firm paid an annual commitment fee of one-half of one percent of the unused balance of the loan commitment.On the used portion of the loan, Inland paid 1.5 percent above prime for the funds actually borrowed on an annual simple interest basis.The prime rate was at 9 percent for the year.If Inland borrowed R6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total rand cost of the loan agreement for one year?

Accepted Answer

The answer of Inland Oil arranged a R10,000,000 revolving credit...

Question 20

Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days.Out of convenience, your firm is not taking discounts, but is paying after 20 days, instead of waiting until day 30.You point out that the approximate cost of not taking the discount and paying on day 30 is around 37 percent.But since your firm is not taking discounts and is paying on day 20, what is the effective annual percentage cost (not approximate) of your firm's current practice, using a 360-day year?

Accepted Answer

The answer of Suppose the credit terms offered to your...

Quiz 16: Managing Short-Term Liabilities Financing

Your firm buys on credit terms of 2/10, net 45, and it always pays on day 45.If you calculate that this policy effectively costs your firm R157,500 each year, what is the firm's average accounts payable balance?

A firm is offered trade credit terms of 2/8, net 45.The firm does not take the discount, and it pays after 58 days.What is the effective annual cost of not taking this discount? (Note: Do not use the approximate cost.)