Question 1

Storm Electronics has set up a formal line of credit of $2 million with First Kentucky Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 60 basis points on the unused balance. The firm borrowed $1,500,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to two decimal places.

Accepted Answer

To calculate the effective interest rate, we need to consider both the interest rate charged on the borrowed amount and the annual fee on the unused balance.

For the amount borrowed of $1,500,000, the interest charged would be:

Interest = $1,500,000 x 6.25% = $93,750

For the unused balance of $500,000 ($2,000,000 - $1,500,000), the annual fee would be:

Annual fee = 0.0060 x $500,000 = $3,000

Total cost of credit = Interest + Annual fee = $93,750 + $3,000 = $96,750

To calculate the effective interest rate, we divide the total cost of credit by the amount borrowed, and express it as a percentage:

Effective interest rate = ($96,750 / $1,500,000) x 100% = 6.45%

Therefore, the answer is B (6.45%).

Question 2

Which of the following is a short-term financing instrument?

Accepted Answer

All of the options listed are considered short-term financing instruments. Accounts payable is a short-term liability, bank loans with a maturity of less than 1 year are short-term loans, and commercial paper is an unsecured, short-term debt instrument issued by corporations.

Question 3

Porter Corp. has just signed up for a lockbox. Management expects the lockbox to reduce the mail float by 2.3 days. The firm's sales on average are $41,250 a day, with the average check being $165. The bank charges $0.39 per processed check. Assume that there are 270 business days in a year and the opportunity cost of funds is 5 percent. What will the firm's savings be from using the lockbox?

Accepted Answer

The firm's savings from using the lockbox will be $3,427.50. This is calculated as follows:Reduced mail float = 2.3 daysAverage daily sales = $41,250Average check amount = $165Number of business days in a year = 270Bank charge per processed check = $0.39Opportunity cost of funds = 5%Reduced mail float in dollars = Reduced mail float * Average daily sales * Average check amount= 2.3 days * $41,250 * $165= $1,546,875Savings from lockbox = Reduced mail float in dollars * Bank charge per processed check * Number of business days in a year * Opportunity cost of funds= $1,546,875 * $0.39 * 270 * 0.05= $3,427.50

Question 4

Which of the following statements is NOT true?

Accepted Answer

Firms using a maturity matching strategy fund their permanent working capital and fixed assets with long-term financing, but their seasonal working capital needs are funded with short-term borrowing. Therefore, statement A is not true.

Question 5

Gibbs, Inc. has just set up a formal line of credit of $1 million with First National Bank. The line of credit is good for up to five years. The bank will be charging them an interest rate of 6.25 percent on the loan, and in addition the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $600,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to 2 decimal places.

Accepted Answer

First, we need to find out the annual fee the firm will pay on the unused balance of the credit line.

Annual fee = 0.50% x ($1,000,000 - $600,000) = $2,000

Next, we need to calculate the total interest expense the firm will incur on the $600,000 borrowed.

Total interest expense = $600,000 x 6.25% = $37,500

The effective interest rate on the line of credit can be calculated as follows:

Effective interest rate = (Total interest expense + Annual fee)/Amount borrowed

Effective interest rate = ($37,500 + $2,000)/$600,000 = 6.58%

Therefore, the firm's effective interest rate on this line of credit is 6.58%.

Question 6

Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 percent. The loan calls for a compensating balance of 8 percent. What is the effective interest rate for this company? Round your final percentage answer to two decimal places.

Accepted Answer

To find the effective interest rate, we need to first calculate the amount of money Serengeti Travels needs to keep on deposit as a compensating balance. This is 8 percent of the loan amount, which is $50,000 x 0.08 = $4,000.
Then, we need to calculate the interest paid on the loan for one year, which is $50,000 x 0.085 = $4,250.
Next, we divide the interest paid by the amount of money Serengeti Travels actually receives ($50,000 - $4,000 = $46,000) to get the true interest rate: $4,250 / $46,000 = 0.0924, or 9.24%. Therefore, the effective interest rate is 9.24%, which is represented by choice A.

Question 7

Good Homes Furnishings is borrowing $225,000. The loan requires a 10 percent compensating balance, and the effective interest rate on loan is 8.25 percent. What is the stated APR on this loan? Do not round your intermediate calculations, and round your final percentage answer to two decimal places.

Accepted Answer

To find the stated APR, we need to calculate the total amount borrowed, including the compensating balance. Let's call the actual amount borrowed X:
X + 0.10X = $225,000
1.10X = $225,000
X = $204,545.45
Now we can use the formula for effective interest rate:
Effective interest rate = (interest paid / amount borrowed) x 100%
We know that the effective interest rate is 8.25%, and we can calculate the interest paid:
Interest paid = X x 8.25% = $16,875
Now we can solve for the stated APR:
Stated APR = (interest paid / actual amount borrowed) x 100%
Stated APR = ($16,875 / $204,545.45) x 100% = 8.25%
Therefore, the stated APR is 8.25%, which is the same as the effective interest rate. None of the options provided are correct.

Question 8

What are some strategies that financial managers can follow in managing their working capital accounts?

Accepted Answer

The answer of What are some strategies that financial managers...

Question 9

Maggie's Bistro is borrowing $375,000. The loan requires an 8 percent compensating balance, and the effective interest rate on the loan is 10.326 percent. What is the stated APR on this loan? Do not round your intermediate calculations, and round your final percentage answer to two decimal places.

Accepted Answer

To find the stated APR, we need to calculate the percentage of interest charged on the loan amount excluding the compensating balance.
Let X be the interest charged on the loan amount, then:
X = (Effective interest rate * Loan amount) / (1 - Compensating balance)
Substituting the given values, we get:
X = (10.326% * $375,000) / (1 - 8%) = $32,118.75
The total amount that Maggie's Bistro has to pay back is: $375,000 + $32,118.75 = $407,118.75
Therefore, the stated APR on this loan is:
Stated APR = (Interest charged / Loan amount) * 100%
= ($32,118.75 / $375,000) * 100%
= 8.55%
Rounding to two decimal places, we get the answer as 9.5%, which is option B.

Question 10

Reference 14-2: 
Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year.
-How many orders will the dealer need to place this year? Round your answer to the whole number.

Accepted Answer

To determine the number of orders, we need to divide the total number of cars sold in a year by the number of cars that can be ordered in each order. The number of cars sold by Jensen Autos in a year is 700. The cost of placing an order is $1,100, and the carrying cost per car is $120. Therefore, the Economic Order Quantity (EOQ) can be calculated as follows:

EOQ = sqrt[(2 x 700 x $1,100) / $120] = 5.5

Since the EOQ is not a whole number, we can round up to the nearest integer, which gives us the number of orders needed in a year. Therefore, Jensen Autos will need to place 6 orders in the year.

Question 11

Which of the following statements about short-term funding strategy is true?

Accepted Answer

All of the statements are true regarding short-term funding strategy. The first statement highlights the usage of short-term debt in funding seasonal working capital needs and a portion of permanent working capital and fixed assets. The second statement describes the downside of this strategy, which involves the periodic refinancing of a firm's long-term assets over their working lives. The third statement indicates that a firm can take advantage of an upward-sloping yield curve and lower its overall cost of funding by using short-term debt.

Question 12

Reference 14-2: 
Jensen Autos, one of the largest car dealers in Eau Claire, sells about 700 vehicles a year. The cost of placing an order with their supplier is $1,100, and the inventory carrying costs are $120 for each car. Most of their sales are in late fall of each year.
-What is the number of cars per order? Round your final answer to the nearest whole number.

Accepted Answer

The answer of Reference 14-2: 
Jensen Autos, one of the...

Question 13

Pride, Inc. sells $150,000 of its accounts receivable to factors at 2.875 percent discount. The firm's average collection period is 75 days. What is the simple annual interest cost of the factors loan? Round your percentage answer to one decimal place.

Accepted Answer

The simple annual interest cost of the factor's loan can be calculated using the formula for the annual interest rate: $Interest\ Rate = \left(\frac{Discount\ Rate}{1 - Discount\ Rate}\right) \times \left(\frac{365}{Average\ Collection\ Period}\right)$. Plugging in the values: $Interest\ Rate = \left(\frac{0.02875}{1 - 0.02875}\right) \times \left(\frac{365}{75}\right) = 35.5\%$.

Question 14

Which of the following statements about collection time is NOT true?

Accepted Answer

Delivery time or mailing time is part of the collection time, as it is the time it takes for the payment to physically reach the firm. The three components of collection time are mail float, processing float, and availability float. Processing delay is another name for processing float.

Question 15

Ticktock Clocks sells 10,000 alarm clocks each year. If the total cost of placing an order is $65 and it costs $85 per year to carry the alarm clock in inventory, calculate the optimal order size using the EOQ formula. Round your final answer to nearest whole number.

Accepted Answer

The Economic Order Quantity (EOQ) formula is $\sqrt{\frac{2DS}{H}}$, where $D$ is the demand (10,000 clocks per year), $S$ is the ordering cost ($65), and $H$ is the holding cost per unit per year ($85). Plugging in the values, we get $\sqrt{\frac{2*10000*65}{85}} \approx 123.693$, which rounds to 124 clocks.

Question 16

Rocky Corp. has daily sales of $18,100. The financial manager determined that a lockbox would reduce the collection time by 2.2 days. Assuming the company can earn 6 percent interest per year, what are the savings from the lockbox? Round your final answer to the nearest dollar.

Accepted Answer

The savings from the lockbox can be calculated by multiplying the daily sales by the reduction in collection time and the interest rate. The annual interest rate is 6%, so the daily interest rate is 6% / 365 = 0.016438% per day. The savings are calculated as $18,100 * 2.2 days * 0.06 / 365 = $2,389 (rounded to the nearest dollar).

Question 17

Which of the following statements about maturity matching strategy is true?

Accepted Answer

The maturity matching strategy, also known as the matching principle, suggests that the duration of assets should match the duration of the financing. Therefore, seasonal working capital needs (which are short-term) are funded with short-term borrowing, and fixed assets (which are long-term) are funded with long-term financing. This approach also implies that as the level of sales and thus the working capital needs fluctuate seasonally, the amount of short-term borrowing will adjust accordingly.

Question 18

A firm sells $125,000 of its accounts receivable to factors at 3 percent discount. The firm's average collection period is one month. What is the dollar cost of the factoring service?

Accepted Answer

To calculate the cost of factoring, we need to first find the amount of money the firm would have received if it had collected its accounts receivable without factoring.

Since the average collection period is one month, we can assume that the firm would have collected $125,000 in one month had it not factored its receivables.

However, because the firm factored its receivables at a 3% discount, it only received $125,000 - 3%*$125,000 = $121,250.

Therefore, the dollar cost of the factoring service is $125,000 - $121,250 = $3,750.

Hence, the best choice is C).

Question 19

Sun Prairie Traders borrowed $63,000 at an APR of 10 percent. The loan called for a compensating balance of 10 percent. What is the effective interest rate on the loan? Round your final percentage answer to two decimal places.

Accepted Answer

The effective interest rate can be calculated by dividing the interest amount by the actual loan amount available after setting aside the compensating balance. Here, a 10% compensating balance on a $63,000 loan is $6,300, leaving $56,700 available to the borrower. The interest for the year at 10% APR is $6,300. Therefore, the effective interest rate is $6,300 / $56,700 = 0.1111 or 11.11%.

Question 20

Trend, Inc. has just set up a formal line of credit of $5 million with First National Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 7.5 percent on the loan, and in addition, the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $2,300,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to one decimal place.

Accepted Answer

To calculate the effective interest rate, we need to take into account both the interest rate charged on the borrowed amount and the annual fee charged on the unused balance.

For the borrowed amount of $2,300,000, the interest charged in one year would be:

$2,300,000 x 0.075 = $172,500

For the unused balance, the annual fee charged would be:

$5,000,000 x 0.005 = $25,000

Therefore, the total cost of the line of credit in one year would be:

$172,500 + $25,000 = $197,500

To calculate the effective interest rate, we divide the total cost by the amount borrowed:

$197,500 / $2,300,000 = 0.0859 or 8.59%

Rounding to one decimal place, the answer is D) 8.1%.

Quiz 14: Working Capital Management