BEC Finance 2 Flashcards
Which one of the following statements concerning the relationship between the concepts and measurement of capital structure and financial structure of a firm is correct?
The concept and measurement of financial structure (all equity and liabilities) includes the concept and measurement of capital structure (long-term liabilities and equity)
The term “financial structure” refers to which one of the following?
All debt and equity.
Which one of the following most likely would not be considered when computing the weighted average cost of capital?
Short-term debt.
Short-term (working capital) financing is of what length?
One year or less
What is considered in short-term financing?
Current liabilities and current assets that could be used to secure financing (accounts payable, notes payable, letters of credit, commercial paper, accounts receivable)
What do terms 2/10, n/30 mean?
2% discount if paid in 10 days, must be paid in 30
If a firm purchases raw materials from its supplier on a 2/10, net 40, cash discount basis, the equivalent annual interest rate (using a 360-day year) of forgoing the cash discount and making payment on the 40th day is:
The annual interest rate of forgoing the cash discount is calculated as:
[Discount %/(1.00 – Discount %)] × [360/(40 – 10)]
For the facts given, the calculation would be:
[.02/(1.00 – .02)] × [360/30] = .02041 × 12 = .2449 (or 24.49%)
Alpha Company borrowed $20,000 from High Bank, giving a one-year note. The terms of the note provided for 6% interest and required a 10% compensating balance. Which one of the following is the effective rate of interest on the loan?
The effective rate of interest on the loan is 6.7% and is computed as the net proceeds from the loan divided into the cost of the loan. The cost of the loan is $1,200 ($20,000 x .06 = $1,200) and the net proceeds is $18,000 ($20,000 - [.10 x $20,000] = $18,000; the remaining $2,000 must be maintained as a compensating balance. Thus, the effective interest is: $1,200/$18,000 = 6.666%.
Trade accounts payable
Firms routinely buyer goods or services from suppliers on credit. No secured, short-term, highly flexible. Easy to use, interest normally not charged, discount often offered for early payment (2/10, n/30). Disadvantages is it requires payment in short term, high interest if discount not taken and is use-specific.
Accrued accounts payable
Result from benefits or cash received for the related unpaid obligation (ex. wages payable, taxes payable). Funds provide short-term financing for entity. Easy to use, flexible, secured but requires payment in short-term and is use-specific.
Short-term notes payable
Reslut from borrowing, usually from a commercial bank with repayment due in 1 year or less. Usually for a designated purpose, requires a promissory note and carry rate of interest determined by credit rating of borrower. A compensating balance can be required.
Advantages of short-term notes payable
Commonly available, flexible, unsecured, provides cash, short maturity permits refinancing
Disadvantages of short-term notes payable
Poor credit rating results in high interest, requires satisfaction in the short-term, compensating balance can increase cost, refinancing at higher rates may be necessary if interest rates increase
Which one of the following is a formal legal commitment to extend credit up to some maximum amount to a borrower over a stated period?
Revolving credit agreement
Which one of the following would an importer of goods from a new foreign supplier most likely use to assure the supplier of payment?
Letter of credit
Line of credit
An informal agreement between borrower and financial institution whereby the financial institution agrees to a max amount of credit that it will extend to the borrower at any one time.
Revolving credit agreement
Like line of credit except with a formal agreement
Letter of credit
Conditional commitment by a bank to a pay a third party in accordance with specified terms and commitments. (ex. payment to supplier with proof of shipment of goods)
Advantages of credit lines, letters:
Commonly available, flexible, unsecured, line of credit and revolving credit provide cash for general use.
Disadvantages of credit lines, letters:
Poor credit rating results in high interest, involves a fee, satisfaction required in short term, possible compensating balance increases cost, line of credit does NOT legally bind a financial institution
Commercial paper
Short-term, unsecured promissory notes by large, highly creditworthy firms as a form of short-term financing. Can be sold directly to investor through a dealer. Has to be less than 270 days or requires SEC registration.
Advantages of commercial paper:
Interest rate generally lower than other sources, larger amount of funds can be obtained, compensating balance not required. Unsecured, provides cash for general use.
Disadvantages of commercial paper:
Only available to creditworthy firms, requires satisfaction in short-term, lacks flexibility to extend
If Nexco factors $200,000 of its accounts receivable due in 30 days with Factorco and, during that 30 days, $10,000 of those accounts receivable are reversed because the related goods were return or allowances were granted, which one of the following is the amount that Nexco will receive from Factorco at the end of the 30 day period? 10% net recievables held for contingencies.
Since Factorco held back a $20,000 reserve ($200,000 x .10) and since during the 30-day period of the factor agreement only $10,000 of the accounts receivable factored had to be reversed because of sales returns and allowances, at the end of the 30-day period Factorco would pay Nexco the remaining $10,000 ($20,000 reserve - $10,000 reversed = $10,000).
Nexco, Inc. is considering factoring its accounts receivable. Factorco, Inc. has offered the following terms for accounts receivable due in 30 days:
Value of receivables to be held in reserve for contingencies 10%
Following costs are deducted at time accounts are factored:
Interest rate on amounts provided before deducting interest (annual rate) 12%
Factor fee on total receivables factored 2%
If Nexco plans to factor $200,000 of accounts receivable due in 30 days, which one of the following is the amount it will receive from Factorco at the time the accounts are factored?
The amount provided would be $200,000 - $20,000 reserve - $4,000 factor fee = $176,000, for which interest would be charged for 30 days, or 1%. Therefore, the correct amount received would be $176,000 - ($176,000 x .01) = $176,000 - $1,760 = $174,240, not $154,880.
Pledging accounts receivable
Firm pledges some or all accounts receivable as collateral for a short-term loan from a commercial bank or finance company. Interest usually 2% above prime or more, accounts are committed to the lender and lender may assume billing and collection during time of loan. Provides cash for general use.
Factoring accounts receivable
Selling accounts receivable to financial institution (factor). Factor charges a fee based on credit and length of maturity of receivables and extent to which factor assumes responsibility (without recourse means factor bears risk and with recourse means firm must bear some or all of risk of default). Same advantages as pledging accounts receivable. Sale of accounts may alienate customers.
