4) Which alternative should Taggart choose?
A) Alternative #1 since it has the lowest EAR
B) Alternative #2 since it has the lowest EAR
C) Alternative #3 since it has the lowest EAR
D) Alternative #2 since it has the highest actual rate
5) A loan agreement requires that the firm pay interest on the loan and pay back the principal in
one lump sum at the end of the loan is called:
A) a short-term mortgage loan.
B) a single, end-of-period-payment loan.
C) a bridge loan.
D) a line of credit.
6) A short-term bank loan that is often used until a firm can arrange for long-term financing is
called:
A) a committed line of credit.
B) a short-term mortgage loan.
C) a bridge loan.
D) a single, end-of-period-payment loan.
7) A a written, legally binding agreement that obligates the bank to lend a firm any amount up to
a stated maximum, regardless of the financial condition of the firm (unless the firm is bankrupt)
as long as the firm satisfies any restrictions in the agreement is called:
A) a bridge loan.
B) a single, end-of-period-payment loan.
C) a short-term mortgage loan.
D) a committed line of credit.
8) Which of the following statements is FALSE?
A) Bank loans are typically initiated with a promissory note, which is a written statement that
indicates the amount of the loan, the date payment is due, and the interest rate.
B) The most straightforward type of bank loan is a single, end-of-period-payment loan.
C) With a fixed interest rate, the specific rate that the bank will charge is stipulated at the time
the loan is made.
D) One of the primary sources of short-term financing, especially for small businesses, is the
investment bank.
9) Which of the following statements is FALSE?
A) The prime rate is the rate banks charge other banks.
B) With a variable interest rate, the terms of the loan may indicate that the rate will vary with
some spread relative to a benchmark rate, such as the yield on one-year Treasury securities or the
prime rate.
C) With a discount loan, the borrower is required to pay the interest at the beginning of the loan
period.
D) A common benchmark rate is the London Inter-Bank Offered Rate, or LIBOR, which is the
rate of interest at which banks borrow funds from each other in the London inter bank market.
10) Which of the following statements regarding lines of credit is FALSE?
A) The line of credit agreement may also stipulate that at some point in time the outstanding
balance must be zero. This policy ensures that the firm does not use the short-term financing to
finance its long-term obligations.
B) A revolving line of credit is an uncommitted line of credit that involves an informal
agreement from the bank for a longer period of time, typically two to three years.
C) The line of credit may be uncommitted, meaning it is an informal agreement that does not
legally bind the bank to provide the funds.
D) A revolving line of credit with no fixed maturity is called evergreen credit.
11) Which of the following statements is FALSE?
A) Regardless of the loan structure, the bank may include a compensating balance requirement in
the loan agreement that reduces the usable loan proceeds.
B) Another common type of fee is a loan origination fee, which a bank charges to cover credit
checks and legal fees.
C) Firms frequently use lines of credit to finance seasonal needs.
D) The commitment fee associated with a committed line of credit is designed to decreases the
effective cost of the loan to the firm.
12) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. If this
loan has an origination fee of 1%, then the effective annual rate (EAR) for this loan is closest to:
A) 12.0%
B) 12.6%
C) 4.1%
D) 13.8%
13) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. If
Luther’s bank requires that the firm maintain a compensating balance equal to 10% of the loan
amount in a non-interest bearing account, then the effective annual rate EAR for this loan is
closest to:
A) 50.0%
B) 12.6%
C) 14.4%
D) 71.5%
14) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%.
Luther’s bank requires that the firm maintain a compensating balance equal to 5% of the loan
amount in a non-interest bearing account and the bank charges a 1% origination fee. Calculate
the the effective annual rate EAR for this loan.
27.4 Short-Term Financing with Commercial Paper
1) Rearden Metal wants to raise $5 million using six-month commercial paper. The net proceeds
to Rearden will be $4,865,000. The effect annual rate for this financing is closest to:
A) 5.6%
B) 6.6%
C) 7.2%
D) 8.4%
2) Wyatt Oil has an issue of commercial paper with a face value of $10,000,000 and a maturity
of three months. Wyatt received $9,800,000 when it sold the paper. The effect annual rate for
this financing is closest to:
A) 5.6%
B) 6.6%
C) 7.2%
D) 8.4%
3) Galt Industries has issued four-month commercial paper with a $8 million face value. The
firm netted $7,831,000 on the sale. The effect annual rate for this financing is closest to:
A) 5.6%
B) 6.6%
C) 7.2%
D) 8.4%
4) Which of the following statements is FALSE?
A) Unlike long-term debt, because of its short maturity, commercial paper is not rated by credit
rating agencies.
B) The interest on commercial paper is typically paid by selling it at an initial discount.
C) Commercial paper is short-term, unsecured debt used by large corporations that is usually a
cheaper source of funds than a short-term bank loan.
D) Extending the maturity of commercial paper beyond 270 days triggers a registration
requirement with the Securities and Exchange Commission (SEC), which increases issue costs
and creates a time delay in the sale of the issue.
18
5) Which of the following statements regarding commercial paper is FALSE?
A) With dealer paper, dealers sell the commercial paper to investors in exchange for a spread (or
fee) for their services.
B) With dealer paper, the spread increases the proceeds that the issuing firm receives, thereby
decreasing the effective cost of the paper.
C) The minimum face value is $25,000, and most commercial paper has a face value of at least
$100,000.
D) With direct paper, the firm sells the security directly to investors.
6) A firm issued three-month commercial paper with a $2,000,000 face value and received
$1,964,000. The effective annual rate that this firm is paying is closest to:
A) 8.0%
B) 7.5%
C) 1.8%
D) 7.3%
7) Kinston Industries issued $4,000,000 in commercial paper which matures in six months and
received $3,876,000. Calculate the effective annual rate that Kinston is paying.
27.5 Short-Term Financing with Secured Financing
1) Rearden Metal has borrowed $4 million for three months at a stated annual rate of 8%, using
inventory stored in a field warehouse as collateral. The warehouse charges a $10,000 fee,
payable at the end of the month. The effect annual rate on this loan is closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
2) Hammond Motors is considering using a public warehouse loan as part of its short-term
financing. The firm will require a loan of $2 million for three months. Interest on the loan will be
12% (APR, compounded quarterly) to be paid at the end of the quarter. The warehouse charges
1% of the face value of the loan, payable at the beginning of the quarter. The effect annual rate
on this loan is closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
3) d’Anconia Copper has borrowed $5 million for six months at a stated annual rate of 10%,
using inventory stored in a field warehouse as collateral. The warehouse charges a $25,000 fee,
payable at the end of the six months. The effect annual rate on this loan is closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
4) Inventory can be used as collateral for a loan in all of the following ways EXCEPT:
A) a floating lien.
B) a warehouse arrangement.
C) a factoring arrangement.
D) a trust receipt.
5) Which of the following statements is FALSE?
A) If a factoring arrangement is with recourse, the factor will pay the firm the amount due
regardless of whether the factor receives payment from the firm’s customers.
B) In a factoring of accounts receivable arrangement, the firm sells receivables to the lender (i.e.,
the factor), and the lender agrees to pay the firm the amount due from its customers at the end of
the firm’s payment period.
C) Businesses can also obtain short-term financing by using secured loans, which are loans
collateralized with short-term assets—most typically the firm’s accounts receivables or
inventory.
D) Both the interest rate and the factor’s fee vary depending on such issues as the size of the
borrowing firm and the dollar volume of its receivables.
6) Which of the following statements is FALSE?
A) Commercial banks, finance companies, and factors, which are firms that purchase the
receivables of other companies, are the most common sources for secured short-term loans.
B) The factoring arrangement may be without recourse, in which case the lender bears the risk of
bad-debt losses.
C) In a floating lien, general lien, or blanket lien arrangement, specific inventory is used to
secure the loan.
D) If a firm sells its goods on terms of net 30, then the factor will pay the firm the face value of
its receivables, less a factor’s fee, at the end of 30 days.
7) Which of the following statements is FALSE?
A) In a pledging of accounts receivable agreement, the lender reviews the invoices that represent
the credit sales of the borrowing firm and decides which credit accounts it will accept as
collateral for the loan, based on its own credit standards.
B) With a trust receipts loan or floor planning, all inventory items are held in a trust as security
for the loan.
C) If the factoring agreement is without recourse, the borrowing firm must receive credit
approval for a customer from the factor prior to shipping the goods. If the factor gives its
approval, the firm ships the goods and the customer is directed to make payment directly to the
lender.
D) In a warehouse arrangement, the inventory that serves as collateral for the loan is stored in a
warehouse.
22
8) Which of the following statements is FALSE?
A) A public warehouse is a business that exists for the sole purpose of storing and tracking the
inflow and outflow of the inventory.
B) A warehouse arrangement is the riskiest collateral arrangement from the standpoint of the
lender.
C) Because the warehouser is a professional at inventory control, there is likely to be little loss
due to damaged goods or theft, which in turn lowers insurance costs.
D) A field warehouse is operated by a third party, but is set up on the borrower’s premises in a
separate area so that the inventory collateralizing the loan is kept apart from the borrower’s main
plant.
9) The Luther Industries wants to borrow $1 million for two months. Using its inventory as
collateral, it can obtain a 10% (APR) loan (compounded monthly). The lender requires that a
warehouse arrangement be used. The warehouse fee is $10,000, payable at the end of the two
months. Calculate the effective annual rate of this loan for Row Cannery.