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CFIN4
Chapter 16 – Managing Short-Term Liabilities (Financing)
76. In this problem, use the approximation formula to find the cost of trade credit. A firm's payments policy calls for
stretching payments to its supplier, who sells on terms of 3/20, net 60. Payment is made in 90 days, and the cash
saved is invested in a money market mutual fund paying 12 percent interest. This policy is
a net ____.
a. Profitable; gain of about 9 percent on the funds involved. b.
Profitable; gain of about 12 percent on the funds involved. c.
Unprofitable; loss of about 4 percent on the funds involved. d.
Unprofitable; loss of about 9 percent on the funds involved. e.
Insufficient information to solve.
because the firm ha
77. Your company has been offered credit terms on its purchases of 4/30, net 90. What will be the approximate cost of
trade credit if your company pays on the 35th day after receiving the invoice?
a. 30%
b. 300%
c. 3%
d. 87%
e. 156%
78. Phillips Glass Company buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 30 days after
the invoice date. Net purchases amount to $720,000 per year. On average, how much "free" trade credit does
Phillips receive during the year?
a. $30,000
b. $40,000
c. $50,000
d. $60,000
e. $70,000
79. Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The bank offers the choice of a 12 percent
discounted interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments.
What is the effective rate of interest on the 12 percent discounted loan?
a. 10.7%
b. 12.0%
c. 12.5%
d. 13.6%
e. 14.1%
80. If you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, but interest is prepaid
(a discounted loan), then what is your effective annual rate?
a. 14.00%
b. 8.57%
c. 16.28%
d. 21.21%
e. 28.00%
81. Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and harvest its fruit crop. Picard
borrows on a discount interest basis at a simple annual rate of 11 percent. If Picard must actually receive $100,000
net proceeds to finance its crop, then what must be the face value of the note?
a. $111,000
b. $100,000
c. $112,360
d. $89,000
e. $108,840
82. Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year. The firm receives payment from its
harvests sometime after shipment. Due in part to the firm's rapid growth, it has been borrowing to finance its
harvests using 90-day bank notes on which the firm pays 12 percent discount interest. If the firm requires $60,000
in proceeds from each note, what must be the face value of each note?
a. $61,856
b. $67,531
c. $60,000
d. $68,182
e. $67,423
83. Suppose you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest
prepaid (a discounted loan). Also assume that the bank requires you to maintain a compensating balance equal to 20
percent of the initial loan value. What effective annual interest rate are you being charged?
a. 14.00%
b. 8.57%
c. 16.28%
d. 21.21%
e. 28.00%
84. Wentworth Greenery harvests its crops four times annually and receives payment for its crop 90 days after it is
picked and shipped. However, the firm must plant, irrigate, and harvest on a near continual schedule. The firm uses
90-day bank notes to finance its operations. The firm arranges an 11 percent discount interest loan with a 20
percent compensating balance four times annually. What is the effective annual rate of these discount loans?
a. 11.00%
b. 15.94%
c. 11.46%
d. 13.75%
e. 12.72%
85. Inland Oil arranged a $10,000,000 revolving credit agreement with a group of small banks. The firm paid an annual
commitment fee of one-half of one percent of the unused balance of the loan commitment. On the used portion of
the loan, Inland paid 1.5 percent above prime for the funds actually borrowed on an annual simple interest basis.
The prime rate was at 9 percent for the year. If Inland borrowed $6,000,000 immediately after the agreement was
signed and repaid the loan at the end of one year, what was the total dollar cost of the loan agreement for one
year?
a. $560,000
b. $650,000
c. $540,000
d. $900,000
e. $675,000
86. C+ Notes' business is booming, and it needs to raise more capital. The company purchases supplies from a single
supplier on terms of 1/10, net 20, and it currently takes the discount. One way of getting the needed funds would be
to forgo the discount, and C+'s owner believes she could delay payment to 40 days without adverse effects. As an
alternative, C+ could borrow from its bank at a rate of 12 percent, annual compounding, but with discount interest.
Additionally, the bank would require a compensating balance of 20 percent of the loan amount. What is the
difference between the EARs of the two financing sources?
a. 4.83%
b. 5.25%
c. 7.60%
d. 9.44%
e. 12.12%
CFIN4
Chapter 16 – Managing Short-Term Liabilities (Financing)
87. Your firm buys on credit terms of 2/10, net 45, and it always pays on day 45. If you calculate that this policy
effectively costs your firm $157,500 each year, what is the firm's average accounts payable balance?
a. $1,234,000
b. $75,000
c. $157,500
d. $625,000
e. $750,000
88. Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days. Out of convenience, your
firm is not taking discounts, but is paying after 20 days, instead of waiting until day 30. You point out that the
approximate cost of not taking the discount and paying on day 30 is around 37 percent. But since your firm is not
taking discounts and is paying on day 20, what is the effective annual percentage cost (not approximate) of your
firm's current practice, using a 360-day year?
a. 36.7%
b. 105.4%
c. 73.4%
d. 43.6%
e. 106.9%
89. Wicker Corporation is determining whether to support $100,000 of its permanent current assets with a bank note or a
short-term bond. The firm's bank offers a two-year note where the firm will receive $100,000 and repay $118,810
at the end of two years. The firm has the option to renew the loan at market rates. As an alternative, the firm can
sell its own 8.5 percent annual coupon bonds, with $1,000 face value and 2-year maturity, at a price of $973.97.
Comparing the cost of the two alternatives, how many percentage points lower is the interest rate on the less
expensive debt instrument?
a. 0%; the rates are equal.
b. 1.2%
c. 1.0%
d. 1.8%
e. 0.6%
90. Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy. The
firm's annual sales are $400,000; its fixed assets are $100,000; debt and equity are each 50 percent of total assets.
EBIT is $36,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. With a
restricted policy, current assets will be 15 percent of sales. Under a relaxed policy, current assets will be 25 percent
of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?
a. 0%; the ROE's are equal.
b. 6.2%
c. 5.4%
d. 1.6%
e. 3.8%
91. Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The bank offers the choice of a 12 percent
discounted interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments.
What is the approximate effective rate of interest on the 10.19 percent add-on loan?
a. 5.095%
b. 10.19%
c. 12.00%
d. 20.38%
e. 30.57%
92. Every 10 days you receive $5,000 worth of raw materials from your suppliers. The credit terms for these purchases
are 3/20, net 30, and thus far you have been paying on the 30th day after each delivery because you are short of
cash. You have been contemplating taking out a one-year bank loan for $4,850 (97 percent of the invoice amount). If
the effective annual interest rate on this loan is 20 percent, what will be your net dollar savings over the year by
borrowing and then taking the discount? That is, what is the difference between the dollars saved if you take the
discount and the dollars spent on interest expense for the loan?
a. $650
b. $1,240
c. $4,430
d. $2,645
e. −$820
93. Assume that Sunshine Products Inc. has an agreement with Shady Finance Company to factor its receivables.
Shady charges a flat commission of 2 percent of the receivables factored, plus 6 percent a year interest on the
outstanding balance. It also deducts a reserve of 10 percent for returned and damaged materials. Interest and
commission are paid in advance. No interest is charged on the reserve or the commission. If the average level of
outstanding receivables is $700,000, and if they are turned over 4 times a year (hence the commission is paid 4
times a year), then what is the effective quarterly interest rate charged by Shady for this arrangement?
a. 6.05%
b. 3.83%
c. 7.52%
d. 9.31%
e. 10.56%
94. Quickbow Company currently uses maximum trade credit by not taking discounts on its purchases. Quickbow is
considering borrowing from its bank, using notes payable, in order to take trade discounts. The firm wants to
determine the effect of this policy change on its net income. The standard industry credit terms offered by all its
suppliers are 2/10, net 30 days, and Quickbow pays in 30 days. Its net purchases are $11,760 per day, using a 360-
day year. The rate on the notes payable is 10 percent and the firm's tax rate is 40 percent. If the firm implements
the plan, what is the expected change in Quickbow's net income?
a. −$23,520
b. −$32,160
c. +$23,520
d. +$37,728
e. +$62,880
CFIN4
Chapter 16 – Managing Short-Term Liabilities (Financing)
Exhibit 16-1
You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank
requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You
currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on
installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
95. Refer to Exhibit 16-1. How large are your monthly payments?
a. $6,250
b. $7,000
c. $7,500
d. $5,250
e. $6,875
96. Refer to Exhibit 16-1. What is the approximate annual interest rate on this loan?
a. 10.00%
b. 16.47%
c. 18.83%
d. 20.00%
e. 24.00%
CFIN4
Chapter 16 – Managing Short-Term Liabilities (Financing)
Financial Calculator Section
The following question(s) may require the use of a financial calculator.
97. A firm is offered trade credit terms of 2/8, net 45. The firm does not take the discount, and it pays after 58 days.
What is the effective annual cost of not taking this discount? (Note: Do not use the approximate cost.)
a. 21.63%
b. 13.35%
c. 22.95%
d. 15.65%
e. 18.70%
CFIN4
Chapter 16 – Managing Short-Term Liabilities (Financing)
98. The Lasser Company needs to finance an increase in its working capital for the coming year. Lasser is reviewing
the following three options: (1) The firm can borrow from its bank on a simple interest basis for one year at 13
percent. (2) It can borrow on a 3-month, but renewable, loan at a 12 percent simple rate. The loan is a simple
interest loan, completely paid off at the end of each quarter, then renewed for another quarter. (3) The firm can
increase its accounts payable by not taking discounts. Lasser buys on credit terms of 1/30, net 60 days. What is the
effective annual cost (not the approximate cost) of the least expensive type of credit, assuming 360 days per year?
a. 13.0%
b. 12.82%
c. 11.46%
d. 12.12%
e. 12.55%
99. Judy's Fashions Inc. purchases supplies from a single supplier on terms of 1/10, net 20. Currently, Judy takes the
discount, but she believes she could extend the payment to 40 days without any adverse effects if she decided not
to take the discount. Judy needs an additional $50,000 to support an expansion of fixed assets. This amount could be
raised by making greater use of trade credit or by arranging a bank loan. The banker has offered to loan the money
at 12 percent discount interest. Additionally, the bank requires an average compensating balance of 20 percent of
the loan amount. Judy already has a commercial checking account at this bank which could be counted toward the
compensating balance, but the required compensating balance amount is twice the amount that Judy would
otherwise keep in the account. Which of the following statements is most correct?
a. The cost of using additional trade credit is approximately 36 percent.
b. Considering only the explicit costs, Judy should finance the expansion with the bank loan.
c. The cost of expanding trade credit using the approximation formula is less than the cost of the bank loan.
However, the true cost of the trade credit when compounding is considered is greater than the cost of the
bank loan.
d. The effective cost of the bank loan is decreased from 17.65 percent to 15.38 percent because Judy would
hold a cash balance of one-half the compensating balance amount even if the loan were not taken.
e. If Judy had transaction balances that exceeded the compensating balance requirement, the effective cost of
the bank loan would be 12.00 percent.
100. You need to borrow $25,000 for one year. Your bank offers to make the loan, and it offers you three choices: (1)
15 percent simple interest, annual compounding; (2) 13 percent simple interest, daily compounding (360-day year);
(3) 9 percent add-on interest, 12 end-of-month payments. The first two loans would require a single payment at the
end of the year, the third would require 12 equal monthly payments beginning at the end of the first month. What is
the difference between the highest and lowest effective annual rate?
a. 1.12%
b. 2.48%
c. 3.60%
d. 4.25%
e. 5.00%
101. You go to three different banks to borrow $10,000 for one year. Each says it will lend you the money at 10 percent,
but their terms differ as follows:
Bank A: Simple interest
Bank B: Add-on interest
Bank C: Discounted interest
Banks A and C require a single payment at the end of the year. Bank B requires 12 equal monthly payments
beginning at the end of the first month. What is the difference between the highest and lowest effective annual
rate in this case?
a. 13.0%
b. 9.5%
c. 9.0%
d. 8.5%
e. 8.0%
102. Do not use the approximation formula for this problem. Coverall Carpets Inc. is planning to borrow $12,000 from
the bank. The bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent add-on, one-year
installment loan, payable in 4 equal quarterly payments. What is the effective rate of interest on the 10.19 percent
add-on loan?
a. 9.50%
b. 10.19%
c. 15.22%
d. 16.99%
e. 22.05%
