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?
Answer(s): A
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%.
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
Answer(s): D
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.
The one item listed below that would warrant the least amount of consideration in credit and collection policy decisions is the
Answer(s): B
A quantity discount is an attempt to increase sales by reducing the unit price on bulk purchases. It concerns only the price term of an agreement, not the credit term, and thus is unrelated to credit and collection policy.
If the average age of inventory is 90 days, the average age of accounts payable is 60 days, and the average age of accounts receivable is 65 days, the number of days in the cash flow cycle is
Answer(s): C
The cash flow cycle begins when the firm pays for merchandise it has purchased and ends when it receives cash from the sale of the merchandise. Inventory is held for an average of 90 days prior to sale, but the average age of accounts payable is 60 days. Therefore, the average time between outlay and sale is 30 days. Receivables are collected an average of 65 days after sale. Thus, the length of the cash flow cycle is 95 days (30 +65)
Clay Corporation follows an aggressive financing policy in its working capital management while Los Corporation follows a conservative financing policy. Which one of the following statements is correct?
A conservative working capital management financing policy uses permanent capital to finance permanent asset requirements and also some or all of the firm's seasonal demands. Thus, Lott's current ratio (current assets/current liabilities) will be high since its current liabilities will be relatively low. An aggressive policy entails financing some fixed assets and all the current assets with short-term capital. This policy results in a lower current ratio.
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