Corporate Finance BUSI 320 Chapter 8 & 9

Jones Company borrows $125,000 (net) from First National Bank. The bank requires a 20% compensating balance. What is the gross amount of the loan?

$156,250

Which of the following statements regarding factoring receivables are correct? (Check all that apply.)

Factoring a business' receivables is considered one of the more expensive financing methods. The factor usually lends between 75% and 80% of the value of accounts receivable. A factor charges a fee of around 5% of the amount.

To find the future value of a single amount, what table or procedure would you use?

Future value of $1

Capital budgeting technique can be used to:

Introduce a fresh product Purchase new equipment

What does LIBOR indicate?

It is the rate that most international banks charge one another for dollar denominated loans in the London market.

Jones Company accepts credit cards resulting in outright sale of receivables to credit card company. Which of the following is true regarding this

Jones is factoring receivables.

Jones Company borrows from the bank, using the accounts receivable as security. Which of the following are true of this situation?

Jones is probably liable if the customer does not pay Jones is pledging the receivables Jones still owns the receivables

Jones Company borrows $125,000 from First National Bank. The bank requires a 10% compensating balance. Which of the following are true regarding this loan?

Jones will have use of $112,500 Jones will pay interest on $125,000

Which of the following is true regarding blanket inventory liens?

Lender has lien on inventory obtained after loan is made. Specific inventory items are not identified. Lender has lien on all inventory.

To calculate the discount rate in a present value problem in Excel, the formula used is

RATE

What are true statements about pledging accounts receivable? More than one answer may be correct.

The firm is liable for the total amount of the loan. The company pledges its accounts receivable as collateral.

Identify a true statement about self-liquidating loans.

They are often used for seasonal financing and for building up inventories.

Trade credit is another name for

accounts payable

A secured short-term loan that involves either the assignment or factoring of receivables is called ______.

accounts receivable financing

Another term for an annuity due is ______.

an annuity in advance

The assets pledged to secure a loan are called

collateral. secured assets.

Present value tables provide

conversion factors to convert future values to present values.

Expressed in graphical form, the bars showing the present value will ______ if the number of periods increase.

decrease

An increase in the number of periods will ______ the present value of a single sum to be received in the future.

decrease Reason: The PV represents that amount one would have to pay today to receive the lump sum in the future. If the number of periods (N) is higher then the initial investment (PV) required will be lower because it will earn more interest over the longer period time.

An increase in the number of periods will ______ the present value of a single sum. An increase in the number of periods will _____ the present value of a single sum to be received in the future.

decrease Reason: The PV represents the amount one would have to pay today to receive a specific lump sum in the future. If the number of compounding periods is higher then the initial investment (PV) required will be lower because it will earn more interest over the extra periods.

An increase in the interest rate will:

decrease the present value increase the future value Reason: The PV represents the amount one would have to pay today to receive a specific lump sum in the future. If the interest rate is higher then the initial investment (PV) required will be lower because it will earn more interest over time.

Agreements to maintain compensating balances should be ____ in the financial statements.

disclosed

If the bank uses a ______ loan and deducts the interest in advance, the effective rate of interest increases

discounted; increases

Commercial bank _____provide short-term financial capital to businesses, and the financing of consumer purchases such as durable goods.

funding

The ______ the annuity payment "PMT", the ______ the present value of the annuity.

higher; higher lower; lower

The present value of money received today is _____ the same amount of money that will be received a year from today. Multiple choice question. more than

less than Reason: Inflation causes the value of a sum of money to decrease over time while interest earned on a sum of money causes it to increase in value over time. So, money received sooner is worth more than money received later. This describes the concept of time value of money (TVM).

A company that secures a loan from a financial institution by pledging accounts receivable balances as collateral will recognize a ______ in the financial statements.

loan payable

A company that has a positive net credit position is considered a ______ of trade credit.

net provider

A company that has a higher accounts payable balance than accounts receivable balance is considered a _____ of trade credit.

net user

A company that has a higher accounts payable balance than accounts receivable balance is considered a ______ of trade credit.

net user

Some advantages of commercial paper are

no compensating balance requirement assets may not be mortgaged may have below market interest rate

The factors needed to compute the interest rate on an annuity are:

payment amount present value number of periods future value

An installment loan usually requires

payment of accrued interest & part principal. a series of equal payments.

Many investments require a series of _____ which makes understanding the present value of a(n) ____important.

payments; annuity

Present value refers to

the amount that must be invested today to realize a specific amount in the future.

For an annuity due,

the beginning of the annuity coincides with the first payment in the annuity.

In solving a general annuity problem, the interest rate that should be used is

the equivalent periodic rate per payment period. Reason: In solving a general annuity problem, the equivalent periodic rate per payment period, i2 = (1 + i)c − 1, should be used.

The time between the sale and the due date of payment is called:

the payment period

Your insurance agent wants to sell you an annuity consisting of 20 equal end of year payments of $10,000 each, starting at the end of this year. Your desired rate of return for investments of this type is 7 percent. What is the most you would pay for this annuity today?

$105,940.14 Reason: Correct. PV = 10,000[1/0.07 − 1/0.07(1.07)20] = 105,940.14.

If Anita wishes to accumulate $11,734 after five years at an 8 percent interest rate, how much must should Anita set aside at the end of each of the five periods? The following table shows future value of annuity of $1:

$2,000

Find the present value of 20 quarterly payments of $3,000 each to be received over the next five years. The stated interest rate is 5 percent per annum.

$51,506

Which formula represents a present value factor?

1 / (1 + r)t

A firm borrows $100,000 at 10 percent annual interest plus a 5 percent compensating balance requirement. As a result, the effective interest rate is ______ percent.

10.53 Reason: (.1 × $100,000)/[$100,000 × (1 - .05)] = 10.53%

An annuity is defined as

An annuity is defined as

Review the following statements and select the one which is true regarding an ordinary annuity.

An ordinary annuity is a series of equal payments occurring at the end of the period at equal intervals.

Joe is offered 5% simple interest at Bank A and 5% annual compound interest at Bank B. At the end of one year

Both banks would pay the same

Tricon Co. sells $10,000 of its accounts receivables and is charged a 5% factoring fee. It records this sale with a debit to:

Cash for $9,500. Reason: Cash is debited for $9,500. $10,000 x .05=$500. $10,000-500=$9,500.

How did the credit crunch in 2007 and 2008 lead to the near collapse of the economy?

Companies went bankrupt. People lost their jobs. Consumers stopped purchasing.

For which of the following would time value of money be a factor when considering an investment in or sale of an asset?

Dividends to be received from the investment Investment in a pension plan A buy vs. lease decision for an asset

The two variables that determine the interest factor in a TVM table are the number of periods and the future value.

False

A 5/10, net 30 cash discount means that the customer will receive a 10% discount if they remit funds 5 days after billing.

False - Reason: A 5/10, net 30 cash discount means the customer will receive a 5% discount if they remit funds 10 days after billing.

What is compound interest?

Interest which is calculated on the initial deposit plus the accumulated interest of prior periods.

Which of the following is a simple annuity due?

Lucas makes deposits of $200 at the beginning of every month for 10 years into an account earning interest of 5% compounded monthly. Reason: This is a general ordinary annuity since the payments are at the end of the payment interval and the payment interval doesn't coincide with the compounding frequency.

hich of the following are common methods for calculating the time value of money?

Mathematical formulas Time Value Tables Financial calculators Spreadsheets

The basic present value equation is ______.

PV = FVt/(1 + r)t

You would like to invest $200,000 of retirement savings into an annuity that will pay you equal payments at the beginning of every month for 20 years. To find out how much those monthly payments will be, which of the following would be the correct formula to choose before rearranging for PMT?

PV(due) = PMT[1−(1+i)−n/i]1×(1+i)

To find the present value of a single sum, what table or procedure would you use?

Present value of $1

The i value in present and future value tables refers to what?

The annual interest rate divided by number of compounding periods per year.

Which of the following is true regarding a deferred annuity?

The period of deferral can end on either the date of the first payment or one payment interval prior to the first payment in the annuity. Reason: Any situation involving a deferred annuity can be seen either as a period of deferral followed by an annuity due, or as a period of deferral followed by an ordinary annuity.

What are some characteristics of commercial paper?

at least $25,000 unsecured short term

To calculate the present value of an annuity

each individual payment is discounted back to the present and then all of the discounted payments are added up. Reason: To solve for the PV of an annuity we must be given N, I/Y, and PMT (FV is assumed to be $0)

The sale of accounts receivables to obtain short-term financing is referred to as ______ receivables.

factoring

Goods in process used as collateral typically qualify a firm for a higher loan than raw material or finished goods.

false

A decrease in the interest rate _____ the present value of a single sum to be received in the future

increases Reason: The PV represents the amount one would have to pay today to receive a specific lump sum in the future. If the interest rate is lower then the initial investment (PV) required will be higher because it will earn less interest over time.

In finance, an annuity due:

involves equal cash flows paid at the beginning of each period

Commercial banks use money from their customers' checking accounts to offer ______ that provide short-term financial capital to businesses, and to finance consumer purchases of durable goods such as automobiles.

loans; funds

The financial calculator does not require us to use the _____ function.

log

A compensating balance requirement is similar to a ______ requirement.

minimum balance

Commercial paper is traded in the

money market

The present value of money received today is ______ the same amount of money that will be received a year from today.

more than Reason: Inflation causes the value of a sum of money to decrease over time while interest earned on a sum of money causes it to increase in value over time. So, money received sooner is worth more than money received later. This describes the concept of time value of money (TVM).

When using the time value tables, the interest factor that is looked up (i.e., PVIF, PFIVA, FVIF, FVIFA) is then _____ the dollar amount of the known variable (PV, PMT, or FV).

multiplied by

The number of periods (n) and interest rate (i) per period used in calculating the present value of an annuity that is paid monthly over 5 years at 12% annually are ______.

n=60; i=1% Reason: The number of periods is the total number of interest payments which is 60 (=12 payments per year times 5 years).

What factors must be known in order to calculate the current value of an annuity?

number of periods interest rate amount of each annuity payment

In contrast to pledging accounts receivables, when factoring is used, the accounts receivables are ______ to the non-bank company providing the financing.

sold

An annuity factor is

the term used to compute the present value of the stream of payment

Credit crunch are the result of the following:

tightening of money supply growth increase in interest rates

Foreign loan rates are often lower than U.S. loan rates which creates an incentive for US firms to utilize foreign borrowing.

true

The method of controlling pledged inventory in which the lender has a general claim on the borrower's inventory is called a blanket inventory lien.

true

True or false: Because there are so many ways to structure loan repayment schedules, no one formula is applicable for computing the APR

true

True or false: When calculating the present value of an annuity using the financial calculator, you enter the cash flows of the annuity using the PMT key.

true

Jones company is considering changing its credit term from 30 days to 45 days. If daily credit sales are $3,000 and the balance in accounts payable is $120,000, then as a result of this change, the company's net trade credit position will become:

$15,000

Calculate the effective interest rate (APR) on a 6-month loan of $6,000 at a 10 percent interest rate (discount basis).

10.53% Reason: = ($6,000 × 10% × (6 / 12)) / (($6,000 - 300) × (6 / 12)) = 10.53%

Calculate the interest rate with compensating balance given annual interest rate of 20 percent and a compensating balance of 4 percent.

20.83 percent

Trade credit is usually extended for

30 to 60 days

Failing to pay in time to take the cash discount when the terms are 2/10 Net 30 results in an interest rate of approximately

37% Reason: Cost of failing to take a cash discount = (2%/(100% - 2%) X (360 / (30 - 10)= 36.73%

A firm has an operating cycle of 87 days, an inventory period of 36 days, and an average payment period of 39 days. How long is the cash cycle?

48 days Reason: Cash cycle = 87 days - 39 days = 48 days

Ezze Mattress needs to raise $200,000 for 6 months. The bank quotes a discount interest rate of 7.5% but does not require compensating balances. What is the effective annual interest rate on this loan?

7.84% (1 / 1 - (7.5% / 6)))6 - 1 = 7.84%

True or false: Commercial paper represents a long-term, secured promissory note issued to the public in minimum units of $25,000.

False

True or false: In the last decade there has been a sharp decline in the use of the term loan

False

For which of the following would time value of money be a factor when considering an investment in or sale of an asset?

Sale of an asset on an installment contract Purchase of an asset on an installment contract Purchase of an annuity

True or false: The time value of money is the concept that $100 received in the future is not worth as much as $100 received today (the present).

True

True or false: Working out the implied interest rate on an annuity allows you to compare whether the annuity is a good investment.

True

rue or false: For a simple annuity, the value of n means the total number of payments which coincides with the total number of compounding periods.

True Reason: For a simple annuity, the payment interval and the compounding frequency match. Therefore, the the total number of payments coincides with the total number of compounding periods.

The present value of an annuity is the value today of a series of equal payments to be received in the future

True Reason: The present value of an annuity is the sum of the discounted values of a series of payments to be received in the future

Match the situation on the left with the appropriate time value of money calculation on the right.

Value of $1,000 to be received in 5 years - Present Value of $1 Value in 5 years of $1,000 invested today - Future Value of $1 Value today for $1,000 to be received each year for the next 5 years - Present Value of an Annuity Value in 5 years of $1,000 to be invested each year for the next 5 years - Future Value of an Annuity

Present value tables provide conversion factors to convert

future values to present values

As a rule, the future value of a single sum will be ______ its present value.

greater than

Which of the following are the correct number of periods (n) and interest rate (i) per period to use to calculate the present value of a 12% loan that requires quarterly payments of $1,000 over 5 years? (Check all that apply.)

i=3% n=20 Reason: The payments are made quarterly (every 3 months); thus the interest per quarter is 3% (=1/4 x 12%).

A change in credit terms from 1/10 net 30 to 2/10 net 30 would ___ the effective rate for not taking the cash discount.

increase

Expressed in graphical form, the line showing the future value will ______ if the number of periods increase.

increase

For an annuity, an increase in the number of periods will ______ the present value.

increase Reason: Example: For a $100 annuity at 5% interest, the PV for N = 3 equals $272. However, if one extra payment is made (i.e., N=4), the PV increases to $355.

An individual borrows $1,000 from the bank for one year from the bank. The loan requires equal monthly payments. The loan officer states the total interest will be $60. The effective rate on the loan will be

more than 6%

The risks of commercial paper include:

potential for a liquidity freeze possibility of default

An amortization schedule includes:

principal paid. year. closing balance. interest paid. total payment. opening balance.

Amortization is the

process of paying off an installment loan in a series of equal payments consisting of both principal and interest

A positive net credit position would indicate that

receivables are more than payables

The arrangement where goods can only be moved with permission of the lender is called

warehousing

Asset backed securities

were responsible for part of the financial crisis of 2007 are nothing more than the sales of receivables through public offering

Installment loans can be obtained by a venture

with a track record of sales and profits

Accounts receivable sold with the risk of nonpayment by customers assumed by the transferor of the receivables is a sale ____recourse; whereas, receivables sold with the risk of nonpayment assumed by the transferee is a sale ____ recourse.

with; without