Question 1

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 calculate the effective annual rate (EAR) of the discount loan, we need to consider the interest rate, the frequency of compounding, and the effect of the compensating balance.

First, we need to find the periodic interest rate that reflects the 11% discount and the four-times annual compounding. Using the following formula:

Effective annual rate (EAR) = (1 + periodic interest rate/m)^m - 1

Where m is the number of compounding periods per year (m = 4 in this case).

EAR = (1 + 0.11/4)^4 - 1 = 0.1206 or 12.06%

Next, we need to adjust for the 20% compensating balance requirement. This means that the company must keep 20% of the loan amount in its bank account, which reduces the effective amount of the loan and hence the effective interest rate.

To adjust for the compensating balance, we can use the following formula:

Adjusted loan amount = Loan amount / (1 - Compensating balance percentage)

Adjusted loan amount = 1 / (1 - 0.20) = 1.25

Now, we can calculate the effective annual rate for the loan with the adjusted loan amount:

EAR = (1 + periodic interest rate/m)^m - 1

EAR = (1 + 0.11/4)^4 - 1 = 0.1206 or 12.06%

Finally, we adjust for the four-times yearly compounding:

EAR = (1 + EAR/m)^m - 1

EAR = (1 + 0.1206/4)^4 - 1 = 0.1594 or 15.94%

Therefore, the effective annual rate of the discount loan is 15.94%, which is closest to option B.

Question 2

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...

Question 3

Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy.The firm's annual sales are $400,000; its fixed assets are $100,000; debt and equity are each 50 percent of total assets.EBIT is $36,000,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 total assets for both policies:

Restricted policy: 
Current assets = 0.15 x $400,000 = $60,000 
Fixed assets = $100,000 
Total assets = $60,000 + $100,000 = $160,000

Relaxed policy: 
Current assets = 0.25 x $400,000 = $100,000 
Fixed assets = $100,000 
Total assets = $100,000 + $100,000 = $200,000

Next, we can calculate the ROE for each policy:

Restricted policy: 
EBIT = $36,000 
Interest expense = 0.10 x $80,000 = $8,000 
Earnings before taxes (EBT) = $36,000 - $8,000 = $28,000 
Taxes = 0.40 x $28,000 = $11,200 
Net income = $28,000 - $11,200 = $16,800 
ROE = $16,800 / $80,000 = 0.21 or 21%

Relaxed policy: 
EBIT = $36,000 
Interest expense = 0.10 x $100,000 = $10,000 
EBT = $36,000 - $10,000 = $26,000 
Taxes = 0.40 x $26,000 = $10,400 
Net income = $26,000 - $10,400 = $15,600 
ROE = $15,600 / $100,000 = 0.156 or 15.6%

The difference in projected ROEs between the restricted and relaxed policies is:

0.21 - 0.156 = 0.054 or 5.4%

Therefore, the best choice is C, with an explanation that the difference in projected ROEs between the restricted and relaxed policies is 5.4%.

Question 4

Exhibit 16-1
You have just taken out a loan for $75,000. 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 $20,000 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 5

Exhibit 16-1
You have just taken out a loan for $75,000. 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 $20,000 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 6

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 7

Suppose you borrow $2,000 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 answer of Suppose you borrow $2,000 from a bank...

Question 8

You need to borrow $25,000 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 answer of You need to borrow $25,000 for one...

Question 9

Every 10 days you receive $5,000 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 $4,850 (97 percent of the invoice amount).If the effective annual interest rate on this loan is 20 percent,what will be your net dollar savings over the year by borrowing and then taking the discount? That is,what is the difference between the dollars saved if you take the discount and the dollars spent on interest expense for the loan?

Accepted Answer

The answer of Every 10 days you receive $5,000 worth...

Question 10

Wicker Corporation is determining whether to support $100,000 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 $100,000 and repay $118,810 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 $1,000 face value and 2-year maturity,at a price of $973.97.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 answer of Wicker Corporation is determining whether to support...

Question 11

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

First, we need to calculate the effective cost of forgoing the discount:
Effective annual cost = [(1 + Discount %)/(1 - Discount %)]^ [365/(Days payable - Discount period)] - 1
Effective annual cost = [(1 + 0.01)/(1 - 0.01)]^ [365/(40-10)] - 1
Effective annual cost = 9.84%

Next, we need to calculate the effective cost of borrowing from the bank:
Compensating balance = 20% of loan amount = 0.2x
Amount available for borrowing = Loan amount - Compensating balance
Loan amount = Amount needed / (1 - Compensating balance %) = Amount needed / (1 - 0.20)
Loan amount = Amount needed / 0.80
Interest = Loan amount x Rate = (Amount needed / 0.80) x 0.12
Amount received = Amount needed - Interest = Amount needed - (Amount needed / 0.80 x 0.12) = Amount needed x 0.90
Effective rate = (Amount needed x 0.10) / (Amount needed x 0.90) = 0.1111 = 11.11%

Therefore, the difference between the two financing sources is:
Difference = 11.11% - 9.84% = 1.27% = 1.27/100 = 0.0127 = 1.27%

Converted to EAR = (1 + 0.0127)^365 - 1 = 4.83%

Thus the best choice is to forgo the discount and delay payment to 40 days.

Question 12

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 $157,500 each year,what is the firm's average accounts payable balance?

Accepted Answer

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

Question 13

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 $11,760 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 expected change in Quickbow's net income can be calculated by first determining the savings from taking the trade discounts and then subtracting the interest expense on the notes payable, adjusted for the tax effect. Savings from discounts = $11,760 * 2% * 360 = $84,672 annually.Interest expense on the notes payable = ($11,760 * 360) * 10% = $423,360 * 10% = $42,336 annually.After-tax interest expense = $42,336 * (1 - 0.40) = $42,336 * 0.60 = $25,401.6.Net increase in income = Savings from discounts - After-tax interest expense = $84,672 - $25,401.6 = $59,270.4.However, since this option is not available, the closest correct answer based on the calculation method provided is D) +$37,728, indicating a possible miscalculation in the explanation provided. The correct calculation involves understanding the cost of not taking the discount versus the cost of borrowing to take the discount, and then adjusting for the tax impact. The discrepancy suggests a need to reevaluate the calculation steps or assumptions made.

Question 14

You go to three different banks to borrow $10,000 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

The answer of You go to three different banks to...

Question 15

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 16

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 $700,000,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 calculate the effective quarterly interest rate charged by Shady, we need to use the following formula:

Effective quarterly interest rate = (1 + total annual interest rate / number of compounding periods per year)^(number of compounding periods per year) - 1

The total annual interest rate charged by Shady is the sum of the 6% interest on outstanding balance and the 2% commission on the factored receivables, which is 8%. Since the commission is paid four times a year, the number of compounding periods per year is 4.

So, the effective quarterly interest rate is:

(1 + 0.08 / 4)^(4) - 1 = 0.0383 or 3.83%

Therefore, the best choice is B.

Question 17

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 $50,000 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 18

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 $60,000 in proceeds from each note,what must be the face value of each note?

Accepted Answer

The answer of Viking Farms harvests crops in roughly 90-day...

Question 19

Inland Oil arranged a $10,000,000 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 $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year,what was the total dollar cost of the loan agreement for one year?

Accepted Answer

The answer of Inland Oil arranged a $10,000,000 revolving credit...

Question 20

Coverall Carpets Inc.is planning to borrow $12,000 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 $12,000...

Quiz 16: Managing Short-Term Liabilities Financing

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.)

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 $157,500 each year,what is the firm's average accounts payable balance?