QUESTION: 223 Topic 4: Part 2 Sec Four (204 to 257)

Gatsby, Inc. is going to begin factoring its accounts receivable and has collected information on the following four finance companies:

Which company will give Gatsby the highest proceeds from a $100,000 account due in 60 days? Assume a 360-day year.

Company
Company B
Company
Company

Answer(s): A

Explanation:

Company A will withhold $6,000 ($100,000 x 6%) as a reserve against returns and allowances and $1,400 ($100,000 x 14%) as a commission. The remaining $92,600 will be reduced by interest at the rate of 15% annually. The interest charge will be $2,315, assuming a 360-day year [($92,600 x 15) x (60-day payment period - 360 days)). The proceeds to be received by Gatsby equal $90,285 ($92,600 - $2,315).

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QUESTION: 224 Topic 4: Part 2 Sec Four (204 to 257)

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Hagar Company's bank requires a compensating balance of 20% on a $100,000 loan. If the stated interest on the loan is 7%, what is the effective cost of the loan?

5.83%
7.00%
8.40%
8.75%

Answer(s): D

Explanation:

Interest on the loan is $7,000 ($100,000 x 7%). Given that the borrower has to maintain a 20% compensating balance, only $80,000 [$100,000 - ($100,000 x 20%)] is available for use. Thus, the company is paying 4) $7,000 for the use of $80,000 in funds at an effective cost of 8.75% ($7,000 ÷ $80,000).

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QUESTION: 225 Topic 4: Part 2 Sec Four (204 to 257)

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A company obtained a short-term bank loan of $250,000 at an annual interest rate of 6%. As a condition of the loan, the company is required to maintain a compensating balance of $50,000 in its checking account. The company's checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a balance of $25,000 in its checking account for transaction purposes. What is the effective interest rate of the loan?

6.44%
7.00%
5.80%
6.66%

Answer(s): A

Explanation:

The $50,000 compensating balance requirement is partially satisfied by the company's practice of maintaining a $25,000 balance for transaction purposes. Thus, only $25,000 of the loan will not be available for current use, leaving $225,000 of the loan usable. At 6% interest, the $250,000 loan would require an interest payment of $15,000 per year. This is partially offset by the 2% interest earned on the $25,000 incremental balance, or $500 Subtracting the $500 interest earned from the $15,000 of expense results in net interest expense of $14,500 for the use of $225,000 in funds. Dividing $14,500 by $225,000 produces an effective interest rate of 6.44%.

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QUESTION: 226 Topic 4: Part 2 Sec Four (204 to 257)

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Merkle, Inc. has a temporary need for funds. Management is trying to decide between not taking discounts from one of their three biggest suppliers, or a 14.75% per annum renewable discount loan from its bank for 3 months. The suppliers' terms are as follows:

Using a 360-day year, the cheapest source of short-term financing in this situation is ,/16

The bank.
Fort Co
Riley Manufacturing Co.
Shad, Inc.

Answer(s): D

Explanation:

The first step is to determine the actual annual percentage interest rate for each of the four options. Assuming a $100 invoice, the Fort Company discount represents interest of $1 on a loan of $99 for 20 days (30-day credit period - 10-day discount period). The annual interest rate is 18.1818% ((360 ÷ 20) periods x ($1 ÷ $99)). The Riley Company discount represents an interest charge of $2 on a loan of $98; i.e., by not paying on the 15th day, the company will have the use of $98 for 45 days (60-day credit period - 15-day discount period). The number of periods in a year would be 8(360 ÷ 45). The interest would be 16.326% ($2 ÷ $98 x 8 periods) The Shad loan would be for $91 at a cost of $3. The loan would be for 75 days (90 - 15). Given 4.8 interest periods in a year (360 ÷75), the annual interest rate would be 14.845% ($3 ÷ $97 x 4.8). The bank loan was quoted at 14.75% on a discount basis. On a $100 note, the borrower would only receive $85.25, giving an interest rate of 17.302% ($14.75 ÷ $85.25). Thus, not paying Shad, Inc.'s invoices on time would be the lowest cost source of capital.

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QUESTION: 223 Topic 4: Part 2 Sec Four (204 to 257)

Explanation:

QUESTION: 224 Topic 4: Part 2 Sec Four (204 to 257)

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QUESTION: 225 Topic 4: Part 2 Sec Four (204 to 257)

Explanation:

QUESTION: 226 Topic 4: Part 2 Sec Four (204 to 257)

Explanation: