39
74) Dazzly Diamond Corp. called for credit at the Home Alone Bank of Paris, TX. The terms included a
$35,000 maximum loan with interest of 1 percent over prime, and the agreement also requires a 15%
compensating balance throughout the year. The prime rate is currently 12 percent.
a. If Dazzly Diamond Corp. maintains a balance in its account of $5,250 to $6,000, what is the effective
cost of credit through the line-of–credit agreement where the maximum amount of the loan is used?
b. Recompute the effective cost of credit to Dazzly Diamond if it will have to borrow the compensating
balance and the maximum amount possible under the agreement.
Keywords: Compensating Balance, Effective Cost of Credit
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
40
75) Quincy Fathows & Co. plans to issue commercial paper for the first time in its 85-year history. The
firm plans to issue $400,000 in 120-day maturity notes. The paper will carry a 13% quarterly compounded
rate with discounted interest and will cost Quincy Fathows $8,000 in advance to issue.
a. What is the effective cost of credit to Quincy Fathows?
b. What other factors should the firm consider in analyzing whether or not to issue the commercial
paper?
Keywords: Commercial Paper, Effective Annual Cost of Credit, Discount Interest
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
41
76) Richenstein Enterprises is in the business of selling dishwashers. The firm needs $192,000 to finance
an anticipated expansion in receivables due to increased sales. Richenstein’s credit terms are net 40, and
its average monthly credit sales are $180,000. In general, the firm’s customers pay within the credit
period; thus, the firm’s average accounts receivable balance is $240,000.
The comptroller of Richenstein Enterprises, Mr. Gee, approached their bank for the needed capital,
pledging the accounts receivable as collateral. The bank offered to make the loan at a rate of 2 percent
over prime plus a 1 percent processing charge on all receivables pledged. The bank agreed to loan up to
80 percent of the face value of the receivables pledged.
a. Estimate the cost of the receivables loan to Richenstein where the firm borrows the $192,000. The
prime rate is currently 13%.
b. Gee also requested a line of credit for $192,000 from the bank. The bank agreed to grant the necessary
line of credit at a rate of 4% over prime and required a 12% compensating balance Gee currently
maintains an average demand deposit of $40,000. Estimate the cost of the line of credit to Richenstein.
c. Which source of credit should Richenstein Enterprises select?
Keywords: Pledging Accounts Receivable, Compensating Balance
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
42
77) Bonneau Sunglass Co. is considering the factoring of its receivables. The firm has credit sales of
$500,000 per month and has an average receivables balance of $1,000,000 with 60-day credit terms. The
factor has offered to extend credit equal to 85% of the receivables factored less interest on the loan at a
rate of 2% per month. The 15% difference in the advance and face value of all receivables factored consists
of a 2% factoring fee plus a 13% reserve, which the factor maintains. In addition, if Bonneau decides to
factor its receivables, it will sell them all, so that it can reduce its credit costs by $2,000 a month.
a. What is the cost of borrowing the maximum amount of credit available to Bonneau through the
factoring agreement?
b. What considerations other than cost should be accounted for by Bonneau in determining whether or
not to enter the factoring agreement?
Keywords: Factoring Accounts Receivable
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
43
78) Discuss the similarities and differences between a line of credit and a revolving credit agreement.
Keywords: Line of Credit, Revolving Credit Agreement
Learning Obj.: L.O. 15.5
AACSB: Reflective Thinking
79) Symco Corp. needs $500,000 for 90 days to get through a period of unexpectedly high oil prices.
Symco’s line of credit with the bank allows the company to borrow at 6% per year with a compensating
balance of 10% of the amount borrowed. Currently, Symco has no money on deposit with the bank.
a. Calculate the amount Symco must borrow to meets its needs plus the compensating balance.
b. What is the annual percentage rate for this financing?
c. If the bank requires discount interest, what is the annual percentage rate for this financing?
Keywords: Line of Credit, Compensating Balance, Annual Percentage Rate, Discount Interest
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
80) AJAX Corp. needs $100,000 for the next 30 days. The company has $100,000 in cash it was expecting to
use to pay off accounts payable in order to take advantage of the 2/10 net 40 credit terms. Another source
of financing is a short-term bank loan with an interest rate of 20%. Would you recommend AJAX borrow
the $100,000 it needs from the bank and use the cash it already has to pay its accounts payable and take
the cash discount, or would you recommend the company forgo the cash discount and use the $100,000 it
has for its financing needs?
Keywords: Cost of Trade Credit, Annual Percentage Yield
Learning Obj.: L.O. 15.5
AACSB: Analytical Thinking
44
81) What are some examples of unsecured and secured sources of short-term credit?
Keywords: Unsecured Short-term Loan, Transaction Loan
Learning Obj.: L.O. 15.5
AACSB: Reflective Thinking
82) What is the difference between a line of credit and a revolving credit agreement?
Keywords: Revolving Credit Agreement
Learning Obj.: L.O. 15.5
AACSB: Reflective Thinking
45
83) List and describe at least three advantages accrue to the user of commercial paper.
Keywords: Combined Leverage
Learning Obj.: L.O. 15.5
AACSB: Reflective Thinking