A manufacturing firm wants to obtain a short-term loan and has approached several lending institutions. All of the potential lenders are offering the same nominal interest rate but the terms of the loans vary. Which of the following combinations of loan terms will be most attractive for the borrowing firm?
Answer(s): A
The most desirable set of terms are those that result in the lowest cost of borrowing. Discount interest results in a higher effective borrowing cost than simple interest because the bank deducts interest in advance so the borrower receives less than the face value of the loan. A compensating balance results in a higher effective borrowing cost because the compensating balance is an amount of cash that the firm is unable to use. The cheapest terms, given that all options have the same nominal interest rate, will be simple interest with no compensating balance.
Hendnx, Inc. is interested in purchasing a $100 U.S. Treasury bill and was presented with the following options:If Hendrix wishes to buy the Treasury bill at the lowest purchasing price, which option should be chosen, assuming a 360- day year?
Answer(s): B
To determine the amount of interest the lender will earn, the 3.5% discount rate is multiplied by the face amount of the Treasury bill). The interest on this Treasury bill is $3.50 ($100 x 3.5% x 1 year); thus, the purchase price is $96.50 ($100 - $3.5).
A company has daily cash receipts of $150,000. The treasurer of the company has investigated a lockbox service whereby the bank that offers this service will reduce the company's collection time by four days at a monthly fee of $2,500. money market rates average 4% during the year, the additional annual income (loss) from using the lockbox service would be
It daily cash receipts are $150,000, and the lockbox service will speed collection by four days, the company will have available an additional $600,000 ($150,000 x 4 days). The result is increased interest revenue of $24,000 ($600,000 x 4% interest rate). However, the $2,500 monthly service charges total $30,000 for the year, which is a $6,000 net loss ($24,000 interest revenue - $30,000 monthly service charges).
Which one of the following statements about trade credit is correct? Trade credit is
Answer(s): C
Trade credit is a spontaneous source of financing because it arises automatically as part of a purchase transaction. The terms of payment are set by the supplier, but trade credit usually requires payment within a short period of time. Trade credit is an important source of credit for all businesses but especially for buyers, such as small businesses, that might not have access to other credit markets. Like all forms of financing, trade credit is subject to the risk of buyer default.
The prime lending rate of commercial banks is an announced rate and is often understated from the viewpoint of even the most credit-worthy firms. Which one of the following requirements always results in a higher effective interest rate?
When a firm borrows money from the bank, it is often required to keep a certain percentage of the funds in the bank at all times. These compensating balances effectively increase the rate of interest on the money borrowed from the bank.
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