978-0134083285 Chapter 15 Part 4

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52) Crawley, Inc. has a line of credit with HNC Bank that allows the company to borrow up to $800,000 at

an interest rate of 12 percent. However, Crawley, Inc. must keep a compensating balance of 18 percent of

any amount borrowed on deposit at the bank. Crawley, Inc. does not normally keep a cash balance

account with HNC Bank. What is the effective annual cost of credit?

A) 12.40%

B) 12.83%

C) 14.63%

D) 15.47%

Keywords: Line of Credit, Compensating Balance, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

53) DAS, Inc. has a line of credit with FBT Bank that allows DAS to borrow up to $400,000 at an annual

interest rate of 11 percent. However, DAS must keep a compensating balance of 25 percent of any amount

borrowed on deposit at the bank. DAS does not normally have a cash balance account with the bank.

What is the effective annual cost of credit?

A) 11.45%

B) 12.59%

C) 14.67%

D) 16.00%

Keywords: Line of Credit, Compensating Balance, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

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

A) mortgage bond

B) line of credit

C) revolving credit agreement

D) transaction loan

Keywords: Unsecured Short-term Loan, Transaction Loan

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

55) The Missouri River Pendant 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 Missouri River?

A) 7.7%

B) 7.5%

C) 7.3%

D) 7.1%

Keywords: Effective Annual Cost of Credit, Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

56) The Native Industries, Inc. 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 Native Industries?

A) 13.46%

B) 14.06%

C) 14.45%

D) 15.38%

Keywords: Commercial Paper, Effective Annual Cost of Credit, Discount Interest

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

57) The effective annual cost of not taking advantage of the 1/10, net 60 terms offered by a supplier is

A) 1.50%.

B) 5.37%.

C) 6.69%.

D) 7.27%.

Keywords: Effective Annual Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

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

common?

A) They all pledge accounts receivables as security.

B) They have nothing in common.

C) They are all unsecured forms of financing.

D) They all use inventory to secure a loan.

Keywords: Inventory Loans, Floating Lien, Chattel Mortgage, Terminal Warehouse Receipt

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

59) The primary advantage that pledging accounts receivable provides is

A) the flexibility it gives to the borrower.

B) that the financial institution bears the risk of collection.

C) the low cost as compared with other sources of short-term financing.

D) that the financial institution services the accounts.

Keywords: Pledging Accounts Receivable

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

60) The terminal warehouse agreement differs from the field warehouse agreement in that

A) the cost of the terminal warehouse agreement is lower due to the lower degree of risk.

B) the borrower of the field warehouse agreement can sell the collateral without the consent of the lender.

C) the warehouse procedure differs for both agreements.

D) the terminal agreement transports the collateral to a public warehouse.

Keywords: Terminal Warehouse Agreements, Field Warehouse Agreement, Inventory Loans

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

61) What is the primary advantage of a firm that is able to issue commercial paper to finance its short–

term assets?

A) Commercial paper provides greater flexibility in terms of repayment.

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

C) Commercial paper does not need to be repaid.

D) Commercial paper is guaranteed by the Federal Government

Keywords: Commercial Paper

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

62) Nike Corp. buys on 3/10, net 30 days. What is the nominal cost of interest if Nike does not take

advantage of the trade discount offered? Assume a 360-day year.

A) 12.0%

B) 22.3%

C) 55.7%

D) 66.3%

Keywords: Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

63) Which of the following statements about factoring is true?

A) The firm, not the factor, bears the risk of collecting bad receivables in a factoring arrangement.

B) Factoring involves the outright sale of a firm’s accounts receivable to the factor.

C) The borrowing firm is able to obtain a greater advance against inventory in a factoring arrangement

than in a typical line of credit secured by accounts receivable.

D) Factoring firms sell the receivables of other firms.

Keywords: Factoring Accounts Receivable

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

64) All of the following are true EXCEPT

A) Trade credit represents inventories sold to customers.

B) Temporary investments are current assets that will be liquidated and not replaced within the current

year.

C) Permanent investments are assets a firm expects to hold for longer than one year.

D) Compensating balance requirements increase the cost of financing.

Keywords: Trade Credit, Temporary Investments, Permanent Investments, Compensating Balances

Learning Obj.: L.O. 15.5

AACSB: Reflective Thinking

65) Calculate the effective cost of the following trade credit terms if the discount is forgone and payment

is made on the net due date.

a. 2/10 net 50

b. 2/15 net 60

c. 2/20 net 45

Keywords: Cost of Trade Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

66) The Rosewood Corporation established a line of credit with a local bank. The maximum amount that

can be borrowed under the terms of the agreement is $500,000 at a rate of 10 percent. A compensating

balance averaging 15 percent of the loan is required. Prior to the agreement, Rosewood had maintained

an account at the bank averaging $25,000. Any additional funds needed for the compensating balance will

also have to be borrowed at the 10 percent rate. If the firm needs $280,000 for 6 months, what is the

annual cost of the loan?

Keywords: Annual Cost of Credit, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

67) Worthington, Inc. is planning to issue $7,500,000 in 120-day maturity notes carrying a rate of 11

percent per year. Worthington‘s commercial paper will be placed at a cost of $35,000. What is the effective

cost of credit to Worthington?

Keywords: Commercial Paper, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

68) The Smith Corporation is a maker of fine stereo components and presently has finished goods

inventories of $800,000. They need a short-term bank loan of $400,000 for three months. The bank has

proposed two different financing arrangements. The first is a floating lien arrangement at a rate of 22

percent. The second proposal is for a terminal warehouse arrangement at 11 percent. Under the latter

proposal, Smith will pay $1,000 a month plus round trip shipping expense of $6,000. Which source of

credit should be selected by the Smith Corporation? Explain.

Keywords: Floating Lien, Terminal Warehouse Arrangement

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

69) MovieTone, Inc. is a producer and distributor of specialty DVDs. It sells directly to large retail firms

on terms of net 60 and has average monthly sales of $350,000. It has recently decided to pledge all of its

accounts receivable to its bank. The bank advances up to 80 percent of the face value of these receivables

at a rate of 4 percent over the prime rate, while charging 2.5 percent on all receivables pledged for

processing to cover billing and collection services. Prior to this arrangement MovieTone was spending

$50,000 a year on its credit department. The prime rate is 6 percent.

a. What is the average level of accounts receivable?

b. What is the effective cost of using this short-term credit for one year?

Keywords: Pledging Accounts Receivable, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

70) The effective interest rate on short-term loans from Bank A is 12.5 percent per year. Bank B claims that

their interest rate is only 11 percent per year. However, Bank B charges interest on a discount basis.

Which bank is charging the lowest effective rate of interest on a one–year loan?

Keywords: Discount Interest, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

71) AAC, Inc. is planning to issue $5,000,000 in 180-day maturity notes paying a rate of 12 percent per

annum. The company expects to incur costs of approximately $20,000 in dealer placement fees and other

expenses of issuing the commercial paper. The company plans to back up their commercial paper offering

with a line of credit from a bank for $5,000,000. The compensating balance requirement is 10 percent of

the line of credit. The company normally maintains $450,000 in its accounts with the bank. What is the

effective cost of the commercial paper offering?

Keywords: Commercial Paper, Effective Cost of Credit, Compensating Balance

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

72) Your company needs to pay $10,000 for the overhaul of five trucks. A bank offers you a loan at 18

percent per annum with a compensating balance requirement of 15 percent of the loan amount. You plan

to borrow the money for 9 months and currently do not have any account with this bank. What is the

effective cost of the loan?

Keywords: Compensating Balance, Effective Cost of Credit

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking

73) Crenshaw Inc. has a $400,000 line of credit with a local bank. The bank requires a compensating

balance of 10% of the loan and extends credit to Crenshaw at 1% over the current prime rate. Crenshaw

needs the use of $200,000 for the three-month period. They currently have no deposits with the lending

bank.

a. What will the effective annual cost of this credit be? (Assume a 360-day year and a 9% prime rate.)

b. Using the above information, what would be the effective interest rate if the firm discounted the

interest on the loan?

Keywords: Effective Cost of Credit, Compensating Balance, Discount Interest

Learning Obj.: L.O. 15.5

AACSB: Analytical Thinking