The Red Company has a revolving line of credit of $300,000 with a one-year maturity. The terms call for a 6% interest rate and a 1(2% commitment fee on the unused portion of the line of credit. The average loan balance during the year was $100,000. The annual cost of this financing arrangement is
Answer(s): C
The annual cost of Red's financing arrangement can be calculated as follows Cost = (Amount borrowed x Interest rate) + [(Credit limit - Amount borrowed) x Commitment fee]= ($100,000 *6%) + [($300,000 --$100,000) x .05] = $6,000+$1,000= $7,000
Maple Motors buys axles in order to produce automobiles. Maple carries an average credit balance of $25,000,000 with its axle supplier. The axle supplier provides credit terms of 1/10 net 25. The nominal annual cost of Maple not taking the trade discount is closest to which one of the following? Assume a 360-day year.
Answer(s): D
The cost of not taking a discount can be calculated as follows:Maple's cost is therefore arrived at thusly:Cost = [360 ÷ (25 - 10)] x [1% ÷ (100% - 1%)]= (360 ÷ 15) x (1% ÷ 99%)= 24 x 1.0101%= 24.24%
The best example of a marketable security with minimal risk would be
Of the choices given, the commercial paper of a top-rated (most creditworthy) company has the risk. Commercial paper is preferable to stock or stock options because the latter represent only a residual equity in a corporation Commercial paper is debt and thus has priority over shareholders' claims. Also, commercial paper is a very short-term investment. The maximum maturity allowed without SEC registration is 270 days. However, it can be sold only to sophisticated investors without registration.
If Brewer Corporations bonds ere currently yielding 8% in the marketplace, why is the firms cost of debt lower'?
Because interest is deductible for tax purposes, the actual cost of debt capital is the net effect of the interest payment and the offsetting tax deduction. The actual cost of debt equals the interest rate times (1 -- the marginal tax rate). Thus, if a firm with an 8% market rate is in a 40% tax bracket, the net cost of the debt capital is 4.8%.
In general, it is more expensive for a company to finance with equity capital than with debt capital because
Answer(s): B
Providers of equity capital are exposed to more risk than are lenders because the firm is not obligated to pay them a return. Also, in case of liquidation, creditors are paid before equity investors. Thus, equity financing is more expensive than debt because equity investors require a higher return to compensate for the greater risk assumed
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