BUS 201 Corporate Finance Homework #2, June 1, 2016

True False Questions

1

Commercial paper is basically unsecured, short-term debt from a large financially secure company.

2

The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an annualized basis.

3

Monthly installment loans usually decrease the effective rate of borrowing.

4

Compensating balances are important for banks because their existence allows them to better protect themselves against default.

5

Although the LIBOR has remained competitive and comparable to the U.S. Prime Rate, it has remained slightly higher than the Prime Rate for over a decade.

6

Commercial paper may show up on corporate balance sheets as either a current asset or a current liability.

7

The use of a compensating balance or minimum required account balance allows the banker to generate a higher return on a loan because not all funds are actually made available to the borrower

8

Trade credit is usually extended for periods of one year or more.

9

Firms can always increase the amount of time they take to pay for purchases (accounts payable) without incurring problems.

10

Larger firms tend to be net users of trade credit, rather than net providers.

11

The largest source of short-term funds for most companies is suppliers (trade credit/accounts payable).

12

ABC Corp. can borrow from its bank at 12 percent to take a cash discount. The terms of the cash discount are 3/10, net 90. ABC Corp. should borrow from the bank to take the discount.

13

The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, Net 30.

14

Stretching the payment period refers to the practice of paying bills past their final due date.

15

A cash discount calls for a reduction in price if payment can be made within a specified time period.

16

Ratio analysis is used as a relative measurement tool; we must compare the results to industry averages.

17

As interest rates rise, the cost of borrowing goes down.

18

Short term lenders are most interested in Liquidity Ratios

19

Long term lenders are most interested in Leverage Ratios

20

Stockholders are most interested in Profitability Ratios

Multiple Choice Questions

1

From the banker's point of view, short-term bank credit is an excellent way of financing

A.

fixed assets.

B.

working capital needs.

C.

repayment of long-term debt.

D.

plant & equipment

2

The firm's net credit position is its:

A) assets minus liabilities

B) bank float

C) accounts receivables minus accounts payable

D) current assets minus current liabilities

3

The London Interbank Offered Rate (LIBOR)

A.

competes with the U.S. Prime Rate for those companies with an international presence.

B.

has been lower than the U.S. Prime Rate for at least the last decade.

C.

is the interest rate banks in England charge each other for short term loans

D.

All of these options are correct.

4

General Rent-All's officers arrange a $50,000 loan. The company is required to maintain a minimum checking account balance of 10% of the outstanding loan. This practice is called

A.

an installment loan.

B.

a compensating balance.

C.

a discounted loan.

D.

a balloon payment.

5

Analog Computers needs to borrow $475,000 from the Midland Bank. The bank requires a 15% compensating balance. How much money will Analog need to borrow in order to end up with $475,000 spendable cash?

A.

$546,250

B.

$758,264

C.

$558,824

D.

None of these options

6

If Analog Computers can borrow at 8% for 180 days. What is the effective rate of interest on a $1,000,000 loan where a 15% compensating balance is required?

A.

18.80%

B.

17.27%

C.

9.41%

D.

None of these options

7

A term loan is usually characterized by

A.

a maturity of one to seven years.

B.

a variable interest rate.

C.

monthly or quarterly installment payments.

D.

All of these options

8

Kenneth's Arrows and Bows borrow $15,000 for one year at 8% interest. What is the effective rate of interest if the loan is discounted?

A.

8%

B.

9.5%

C.

8.7%

D.

10.5%

9

Ms. Smith borrowed $2,000 at an 8% stated rate of interest and was to pay back the loan in 12 monthly payments. What is her effective rate of interest using the installment loan formula?

A.

10.5%

B.

14.8%

C.

18.9%

D.

22.0%

10

Commercial paper is very popular with many firms because

A.

it can usually be issued below the prime rate.

B.

it satisfies the firm's need for long-term funds.

C.

there are no required lines of credit at the bank.

D.

Both A & C

11

ABC Company can borrow from its bank at 12% to take a cash discount. The terms of the cash discount are 2/10, net 50. ABC Company should:

Borrow from the bank to take the cash discount

Not borrow from the bank and not take the cash discount

SHOW YOUR WORK

12

The largest provider of short-term credit for a business is/are:

A) banking organizations

B) suppliers to the firm (trade creditors)

C) commercial paper

D) Eurodollars

13

If a bank offers a firm a simple interest loan of $1,000 for 120 days at a cost of $60 interest, what is the effective rate of interest on the loan?

A) 18%

B) 6%

C) 20%

D) None of the above

14

If a firm is given trade credit terms of 2/10, net 30, then the cost of the firm failing to take the discount is:

A) 2%

B) 30%

C) 36.7%

D 10%

15

Bobs Boxes Inc. has two divisions. Division A has a profit of $165,000 on sales of $3,010,000. Division B is only able to make $38,900 on sales of $392, 000. Based on the profit margins (returns on sales), which division is superior?

16

Use the following information to answer questions 16,17 ,18 19 & 20.

Yasgars Farm Grass Company has $4,000,000 in assets and $2,800,000 of debt. It reports net income of $400,000.

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What is the firms return on assets?

17

What is its return on stockholders equity?

18

If the firm has an asset turnover ratio of 2.5 times, what is the profit margin (return on sales)?

19

What is the Debt to Asset Ratio?