Fundamentals of Business Finance Chapter 15

Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase of $20,000 today. Which of the following payment options makes the most sense as a general rule?

Either pay the bill on day 10 to get the discount, or wait until day 45.

What is the primary advantage of a firm that is able to issue commercial paper to finance its short-term assets?

Interest rates on commercial paper are generally lower than rates on bank loans.

If a firm relies on short-term debt or current liabilities in financing its asset investments, and all other things remain the same, what can be said about the firm's liquidity?

The firm will be relatively less liquid.

Interest costs for short-term debt are generally lower than interest costs for long-term debt because

both the term structure of interest rates generally reflects an upward sloping yield curve and short-term debt is more flexible, allowing a match of short-term needs with short-term financing.

A floating lien, chattel mortgage, or terminal warehouse receipt have which of the following in common?

They all use inventory to secure a loan.

Which of the following sources of short-term financing is likely to have the lowest interest rate?

commercial paper

Jones Company has a cash flow problem. The company owes its suppliers $300,000 on credit terms of 2/10 net 40, but Jones doesn't have the cash to pay during the discount period. Jones, however, can borrow the $300,000 at annual rate of 24%. Should Jones borrow the money to pay its accounts payable?

Yes, the effective cost of forgoing the discount is greater than 24%.

An inventory loan agreement in which the inventories pledged as collateral are physically separated from the firm's other inventory and placed under the control of a third-party is called

a field warehouse agreement.

Which of the following is considered a spontaneous source of financing?

accounts payable

Working capital includes all of the following except:

accounts payable.

Which of the following sources of short-term financing is likely to have the highest interest rate?

accounts receivable loan (pledging of accounts receivable)

Key Enterprises borrows $12,000 for a short-term purpose. The loan will be repaid after 120 days, with Key paying a total of $12,400. What is the approximate cost of credit using the APR , or annual percentage rate, calculation?

10.00%

Penn Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a bank that allows the company to borrow funds with an 8% interest rate subject to a 20% of loan compensating balance. Currently, Penn Inc. has no funds on deposit with the bank and will need the loan to cover the compensating balance as well as their other financing needs. What will be the annual percentage rate, or APR, for this financing?

10.00%

Key Enterprises borrows $12,000 for a short-term purpose. The loan will be repaid after 120 days, with Key paying a total of $12,400. What is the approximate cost of credit using the APY , or annual percentage yield, calculation?

10.34%

The Stuart Glass Company established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement, Stuart had no deposit with the bank. Shortly after signing the agreement, Stuart needed $240,000 to pay off a note that was due. It borrowed the $240,000 from the bank by drawing on the line of credit. What is the effective annual cost of credit?

10.67%

Your company is able to arrange financing at either a rate of 12.75% annually, or at a rate of 12% compounded monthly. Assuming financing is needed for one year, which rate is the best?

12% compounded monthly, because the annual percentage yield is 12.68%

Consolidated Industries borrows at prime plus 1.5% on its line of credit. The line requires a 15% compensating balance. If prime rate is 9%, what is the nominal APR of the line of credit?

12.4%

The Jubilee Manufacturing Company is going to issue 180-day commercial paper to raise $25 million. It anticipates a discounted interest rate of 13 percent, and dealer placement costs of approximately $60,000. What is the effective annual cost of credit to Jubilee?

14.45%

Florida Grape Growers (FGG) has a line of credit with Trust Company Bank that allows FGG to borrow up to $400,000 at an annual interest rate of 11 percent. However, FGG must keep a compensating balance of 25 percent of any amount borrowed on deposit at the Trust Company. FGG does not normally have a cash balance account with the Trust Company. What is the effective annual cost of credit?

14.67%

Boeing Corp. buys on 3/10, net 30 days. What is the nominal cost of interest if Boeing does not take advantage of the trade discount offered? Assume a 360-day year.

55.7%

The Stoney River Pennant Company uses commercial paper to satisfy part of its short-term financing requirements. Next week, it intends to sell $18 million in 90-day maturity paper on which it expects to have to pay discounted interest at an annual rate of 7 percent per annum. In addition, Stoney River expects to incur a cost of approximately $25,000 in dealer placement fees and other expenses of issuing the paper. What is the effective annual cost of credit to Stoney River?

7.5%

Assume that Billings, Inc. borrows $5,000,000 for 120 days. The total interest paid is $150,000. What is the APY, or Effective Annual Rate of interest that Billings pays?

9.27%

Which of the following is an advantage of the use of current liabilities to finance assets?

Both more flexibility and lower interest costs

All of the following are potential advantages of commercial paper except

flexible repayment terms.

A company that increases its liquidity by holding more cash and marketable securities is

likely to achieve a lower return on equity because of the smaller rates of return earned on cash and marketable securities compared to the firm's other investments.

Which of the following actions would improve a firm's liquidity?

selling bonds and increasing cash

All of the following are potential disadvantages of short-term debt except:

short-term debt generally has a higher interest cost than long-term debt.

Which of the following is an unsecured short-term bank loan made for a specific purpose?

transaction loan

JoLi Corp. purchases a new delivery van which is expected to increase cash flows for the next 10 years. JoLi can finance the purchase with a standard 48 month vehicle loan, or by getting a 10 year loan from the bank. According to the hedging principle, JoLi should

use the 10-year financing in order to match the cash flow stream from the asset with the financing repayments.

Spontaneous sources of financing include

wages payable.