Financing Option Flashcards
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?
6.7%
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%.
A company’s return on investment is the
Profit margin percentage multiplied by the capital turnover.
Return on investment = Income/Investment
Profit margin percentage = Income/Sales
Capital turnover = Sales/Investment
Therefore: Return on investment = (Income/Sales) x (Sales/Investment) = Profit margin percentage x capital turnover.
This answer correctly states: Profit margin percentage MULTIPLIED by the capital turnover.
Residual income of an investment center is the center’s
Income less the imputed interest on its invested capital.
Residual income is the achieved income of the division less a measure of the minimum required income that should be earned by a division with that amount of capital invested. Residual income = division income - [(imputed interest rate)(division capital)].
Thus, residual income is the amount of income over and above the minimum required of the division with its amount of invested capital. A larger number indicates a more successful division.
Which combination of changes in asset turnover and income as a percentage of sales will maximize the return on investment?
Asset turnover Income as a percentage of sales
Increase Increase
Return on investment = income/investment = (sales/investment x [income/sales]) = (asset turnover) x (income as a percent of sales). This disaggregation of return on investment allows an analysis of the effect of turnover and income as a percent of sales on return on investment. An increase in either or both of the component ratios will result in an increase in return on investment. This makes intuitive sense. The more times assets “turn over” or produce sales in the amount of assets in a period, the higher will be the return on those assets. Similarly, the larger percentage of sales kept by the firm as income, the higher will be return to investment.
Minon, Inc. purchased a long-term asset on the last day of the current year. What are the effects of this purchase on return on investment and residual income?
Return on Investment Residual Income
Decrease Decrease
Acquiring a long-term asset on the last day of the year would decrease the return on investment because a larger asset base would be divided into the net income for the period, and residual income would decrease because the average invested capital, which is multiplied by the hurdle rate of return and subtracted from net income, would increase.
Which of the following terms represents the residual income that remains after the cost of all capital, including equity capital, has been deducted?
Economic value-added.
Economic value-added (EVA) represents the residual income that remains after the cost of all capital, including equity capital, has been deducted. It is calculated as an entity’s net after-tax operating profit less the cost of capital provided by debt holders and shareholders. It is a performance metric intended to measure economic profit, not accounting profit.
Which of the following performance measures may lead a manager of an investment center to forgo investments that could benefit the company as a whole?
Return on investment.
The use of (an expected) return on investment (ROI) as a performance measure for an investment center may lead a manager to forgo investments that could benefit the company as a whole. In an investment center, management is responsible for the center’s revenues, costs and related investments. The basic ROI calculation for an investment center is Center Operating Income/Average Center Operating Assets. Center management would likely forgo an investment opportunity that may provide a more than adequate ROI for the company as a whole, but which would provide a ROI lower than the center’s already existing ROI, which would lower the center’s overall ROI.
B. Residual income.
Which of the following forms of economic activity is considered in macroeconomics, but not in microeconomics?
Individuals receiving payments from business entities.
Individuals receiving payments from business entities is a situation that is considered in both microeconomics and macroeconomics as a fundamental flow in a free-market model. Individuals paying taxes to the federal government is not considered in microeconomics (which considers only the relationship between individuals and businesses), but is considered in macroeconomics, which includes the government sector.
The controller of Gray, Inc. has decided to use ratio analysis to analyze business cycles for the past two years in an effort to identify seasonal patterns. Which of the following formulas should be used to compute percentage changes for account balances for year 1 to year 2?
(Current balance - prior balance) / prior balance.
The correct formula to compute the percentage changes for account balances is (Current balance - prior balance) / prior balance. The numerator computes the change in amount from the prior year balance to the current year balance and the use of the prior year’s balance in the denominator determines the percentage change from the prior year’s balance.
A firm with cash in excess of its immediate needs is considering a temporary investment in newly issued 10-year treasury obligations, which pay a fixed rate of interest.
If the investment will be for one year, which of the following risks, if any, would be of concern?
Default Risk Interest Risk
No Yes
Debt obligations of the U.S. government are considered to be free of the risk of default, therefore risk of default on the debt would not be of concern. Interest rate risk would be of concern. Interest rate risk derives from the effects on market value resulting from changes in the rate of interest in the market. If the interest rate increases relative to the rate at the time the fixed-rate Treasury obligations are acquired, the market value of the Treasury obligations will decrease (and vice versa).
Furthermore, the longer the maturity of the fixed-rate obligations, the greater the influence of a given interest rate change on current market value. Since the Treasury obligation is to be sold in one year, not held to maturity, the value of the obligations at the date of sale will depend on the market interest rate at that time relative to the rate when the obligations are acquired.
According to the 17 COSO control principles, organizational objectives primarily relate to which fundamental component of internal control:
Risk assessment.
According to the COSO principles, risk assessment primarily relates to organizational objectives, risk assessment, fraud, and change management. Organizational objectives link to risk assessment since objectives help to define the risks that are to be assessed.
The demand curve facing a firm in monopolistic competition is
negatively sloped.
The demand curve in monopolistic competition is negatively sloped–the lower the price, the greater the quantity demanded.
The IIA’s International Professional Practices Framework includes among its “mandatory” guidance each of the following elements except
Practice Guides.
Mandatory guidance consists of: (1) Definition of Internal Auditing; (2) Code of Ethics; and (3) International Standards. The “strongly recommended” guidance consists of (1) position papers; (2) practice advisories; and (3) practice guides.
Which of the following information technology (IT) departmental responsibilities should be delegated to separate individuals?
Data entry and application programming.
The separation of the data entry function from the application programming function is critical to the segregation of duties within an IT department. This is because if one both enters data and changes the programs into which those data are entered, one can perpetrate consequential financial frauds. This is why data entry occurs within the operations unit of an IT department and application development occurs within the development function of an IT department. These functions must be kept separate and their duties segregated. Therefore, this is the best answer to the question.
Disco is considering three capital projects that have the following costs and net present values (NPV):
Project Cost NVP
X $40,000 $60,000
Y $60,000 $75,000
Z $50,000 $30,000
Which one of the projects, if any, is not economically feasible?
All of the projects are economically feasible.
Because all of the projects have a positive net present value, they are all economically feasible. NET present value is the difference between present value of cash inflows and cost of the investment.
PEST analysis can be used when considering
domestic locations foreign locations
Yes Yes
PEST analysis, which is concerned with the political, economic, social, and technical characteristics of a nation or region, can be used when considering either a domestic location or a foreign location.
Which one of the following is not an income approach to the valuation of a business?
Comparable sales.
The use of comparable sales is not an income approach to valuation of a business, it is a market approach. Under the comparable sales approach, the value of a business is determined by comparing it to other entities with comparable characteristics for which the value is more readily determinable.
