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16 Jan 2018

Your banker offers several borrowing alternatives. Which has the lowest effective rate?

Select one:

8.75% discount with a 15% compensating balance

9% with a 20% compensating balance

11% simple interest

A vendor offers you trade credit of 2/10, net 45. The value of the discount is the equivalent of ________%.

Select one:

15%

21%

32%

12%

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Jamar Ferry
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17 Jan 2018

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Cost of Bank Loans Del Hawley, owner of Hawley’s Hardware, is negotiating with First City Bank for a 1-year loan of $50,000. First City has offered Hawley the following alternatives. Calculate the effective annual interest rate for each alternative. Which alternative has the lowest effective annual interest rate?

a. A 12% annual rate on a simple interest loan, with no compensating balance required and interest due at the end of the year.

b. A 9% annual rate on a simple interest loan, with a 20% compensating balance required and interest due at the end of the year.

c. An 8.75% annual rate on a discounted loan, with a 15% compensating balance.

d. Interest is figured as 8% of the $50,000 amount, payable at the end of the year, but the $50,000 is repayable in monthly installments during the year.

Hand-to-Mouth is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or taking out a loan. They owe the supplier $13,000, but the supplier will give them a 2% discount if they pay by today (when the discount period expires). That is, they can either pay $12,740 today, or $13,000 in one month when the net invoice is due. Because Hand-Mouth does not have the $12,740 today, or $13,000 in one month when the net invoice is due. Because Hand-to-Mouth does not have the $12,740 in cash right now, it is considering three options:

Alternative A: Forgo the discount on its trade credit agreement, wait and pay the full $13,000 in one month.

Alternative B: Borrow the money from Bank A, which has offered to lend the firm $12,740 for one month at an APR (compounded monthly) of 11.7%. The bank will require a (no-interest) compensating balance of 4.6% of the face value of the loan and will charge a $90 loan origination fee, which means Hand-to-Mouth must borrow even more than the $12,740.

Alternative C: Borrow the money from Bank B, which has offered to lend the firm $12,740 for one month at an APR of 14.9% (compounded monthly). The loan has a 1.1% loan origination fee.

Alternative A: The effective annual cost is ______________________%. (Round to two decemial places)

Alternative B: The effective annual rate is _______________%. (Round to two decimal places)

Alternative C: The effective annual rate is ______________%. (Round to two decimal places)

(Select the best choice below):

A. Alternative B, with the lowest effective annual rate, is the best option for Hand-to-Mouth

B. Alternative C, with the lowest effective annual rate, is the best option for Hand-to-Mouth

C. Alternative A, with the lowest effective annual rate, is the best option for Hand-to-Mouth

D. All the alternatives are equivalent.

QUESTION 1

Flexibility of the source of financing. ____ tends to require fewer specific asset restrictions, while _____ tends to require fewer enterprise restrictions.

a.

Leases; loans
b.

Leases, leases
c.

Loans; loans
d.

Loans, leases

QUESTION 2

_____ is not really buying on credit, whereas _____ is generally free financing for a specified period of time.

a.

Cash on delivery, cash in advance.
b.

Cash in advance; net 30
c.

Net 30, cash in advance
d.

Net 30; 1/15 net 40

QUESTION 3

_____ is often used by manufacturers to significantly lower their production cost. It gives them the ability to produce in a level production mode year round, rather than running two or three shifts at the peak of their demand cycle.

a.

Consignment
b.

Net cash, bill to bill
c.

Seasonal dating
d.

Cash in advance

QUESTION 4

A firm is offered credit terms of 1.5/10, net 40. What would be the cost to this firm of using its vendor as its banker?

a.

18.53%
b.

18.25%
c.

13.90%
d.

17.63%

QUESTION 5

A company estimates its cost of vendor financing (using its vendor as its banker) is 12.2%. It also estimates its effective cost of bank financing to be 9.1%. Which statement best describes this situation?

a.

Can't say for sure what the better funding source would be.
b.

The vendor offers less expensive financing and should be used instead of the bank for that reason.
c.

The company should use its vendor as its financing source, not its bank.
d.

The company should borrow from its bank and take advantage of the trade discount being offered.

QUESTION 6

A company is offered purchase terms of 2/10, net 40. If it can borrow from its bank for 8%, how long would it need to wait to pay its supplier to bring the cost of vendor financing down to 8%, making it a matter of indifference which financing source was used. I.e., instead of paying in 40 days, when would it pay to reduce the cost of vendor financing to 8%, assuming the vendor would permit it?

a.

83 days
b.

93 days
c.

103 days
d.

113 days

QUESTION 7

What is the effective cost of bank financing if the loan amount is $100,000, interest is discounted (advance), a 1% commitment fee is paid up front, and a 9% compensating balance is required? The stated interest rate is 8%.

a.

8.00%
b.

8.98%
c.

10.98%
d.

9.98%

QUESTION 8

Floor planning is best described as:

a.

Consignment with interest
b.

Seasonal dating
c.

Consignment
d.

Receivables financing

QUESTION 9

Coverage ratios as covenants are calculated using values from the _________. Current ratios as covenants are calculated using values from the ______.

a.

Income statement and balance sheet; balance sheet
b.

Income statement; balance sheet
c.

Balance sheet; balance sheet
d.

Income statement; income statement and balance sheet

QUESTION 10

_____________ as a source of short-term financing, is described as spontaneous financing.

a.

Long-term debt
b.

Commercial paper
c.

Bank loans
d.

Trade credit

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