Deck 8: Financing a Business 1: Sources of Funds

Question 1

Outstanding warrants for the Buell Corp. have an exercise price of $1.50. The current market price for Bull shares is $1.75. How much would it cost a purchaser to buy 3,000 warrants?

A) $500
B) $750
C) $4,500
D) $5,000
E) $5,250

Answer 1

B

Question 2

Which of the following is an internal source of financing?

A) Retained earnings
B) Preferred shares
C) Debentures
D) Accounts receivable
E) Common shares

Answer 2

A

Question 3

Five years ago, Raleigh Corporation issued $5 million in 20-year bonds, face value of $1000 and interest at 10% compounded semi-annually, paid twice a year. Interest rates have dropped to 8%. The bonds had a call provision that allowed Raleigh to buy them back at 102.5% of face. Ignoring issuing costs, what is the difference between the total exercise price and the fair value of the bonds?

A) Save $61,840
B) Save $130,070
C) Save $174,340
D) Save $739,602
E) Lose $1,063,160

Answer 3

D

Question 4

ABC Corp. needs $8,000,000 of debt for a quarter share fractional ownership of a Gulfstream IV executive jet. If the company's investment banker has offered to raise the financing by way of a zero coupon (strip) bond with a yield to maturity in 15 years of 6%, what will ABC Corporation's total cash outflow be at maturity?

A) $25.4 million
B) $77.7 million
C) $8.0 million
D) $19.2 million
E) $186.2 million

Question 5

Which of the following is/are pledged as a form of loan security called a floating charge?

A) First claim on a proportion of future sales revenue
B) All of the assets of the business
C) Buildings or land or any other appreciating asset
D) A third party's guarantee of payment
E) Inventory and accounts receivable

Question 6

A form of funds available to non-Canadian borrowers, known as Maple bonds, were developed. Why are attractive to investors?

A) Canadian investors receive an interest adjustment allowing for a lower price on the bonds.
B) Canadian investors are rated AAA and more likely to support their obligations.
C) Canada as a stable efficient capital market allows foreign borrowers to more easily interact with the US regulators.
D) The Canadian capital pool is large enough to warrant the costs of establishing these programs.
E) Foreign borrowers find that Canada has low interest rates and, for some, their currencies have appreciated against the Canadian dollar.

Question 7

If Trundell Co. Ltd. issued 12-year debt by way of a zero coupon (strip) bond with a nominal value of $15,000,000 and received $6,660,200 at issue, what interest rate did Trundell pay on its bond?

A) 16%
B) 7.0%
C) 3.7%
D) 4.4%
E) 25%

Question 8

On April 15, with the Canadian dollar (CAN) trading at $1.016 to one US dollar (USD), Lethbridge Saddlery Ltd. took delivery of $250,000(USD) worth of saddles and tack from a Montana supplier which Lethbridge paid through an operating loan at 5% in US currency. Lethbridge planned to repay the loan out of sales revenue 90 days later. If the exchange rate went to $0.980 CAN to one USD when the loan matured, how much did Lethbridge Saddlery Ltd. pay in interest in Canadian dollars?

A) $3,034
B) $3,131
C) $3,020
D) $12,303
E) $12,700

Question 9

What is the value that will be entered on both sides of Atlas Asbestos Ltd.'s balance sheet if the company's capital leasing contract calls for quarterly payments of $3,535 for five years beginning three months from now at an interest rate of 12% compounded four times year?

A) $52,592
B) $94,987
C) $12,743
D) $22,457
E) $26,404

Question 10

What is an advantage to a business when financing through an issue of preferred shares rather than bonds?

A) Preferred shares trade on stock exchanges as well as OTC (over the counter) making preferred share issues always easier to place.
B) A company is legally obligated to pay interest to its bondholders. Dividends to preferred shareholders can be deferred indefinitely.
C) Preferred shareholders demand a lower rate of return than bondholders.
D) Dividends paid to preferred shareholders can be written off against taxes at a higher rate than interest payments to bond holders.
E) Preferred shareholders demand a lower value of assets to be pledged against the capital they provide to the business than bondholders do.

Question 11

What is an advantage of a loan covenant to the borrower?

A) Greater security against risk exposure.
B) Greater clarity with respect to repayment terms.
C) A more appealing debt issue to the lender.
D) Increased opportunity for subordinate loans.
E) The option for early loan repayment.

Question 12

Outstanding warrants for the common shares of Buell Corp. have an exercise price of $1.50. The present price for Buell's shares is $2.00 per share. If Buell's shares rose by another 20% by what percentage would the value of the warrants increase by?

A) 20%
B) 40%
C) 50%
D) 60%
E) 80%

Question 13

To establish the credit ratings that are used in the financial industry to represent the level of default risk associated with a bond, what do credit rating agencies do?

A) Collaborate with governmental taxation and finance departments.
B) Operate within the provincial securities departments.
C) Assess multiple sources and institutions and work independently.
D) Cooperate with national stock exchanges and investment dealers.
E) Interact with the World Bank and International Monetary Fund to accurately assess all relevant risks.

Question 14

AAA Ltd. has borrowed $15 million dollars at a fixed rate of 8% for seven years to purchase large industrial presses. Last year, BBB Ltd. negotiated a variable rate loan, at a similar amount, currently at 7.5%, for somewhat smaller presses with enhanced finishing features. If the two companies enter into an interest rate swap agreement, which of the following best describes the effects?

A) The remainder of AAA's $15 million is sold to BBB in exchange for an equivalent amount of BBB's $15 million debt.
B) The fixed assets purchased through the $15 million debt by AAA are exchanged for the fixed assets purchased through debt by BBB. The debt contracts do not change hands and a monetary equivalent for accumulated amortization is provided to BBB.
C) The fixed assets purchased through the $15 million loan by AAA are exchanged for the fixed assets purchased through debt by BBB. The debt contracts are re-issued to the exchanging parties to reflect the change in hands of assets and financing.
D) The payments and terms involved in servicing the debt of AAA are assumed by BBB in exchange for AAA taking over the payments and terms involved in servicing BBB's debt. The debt contracts do not formally change hands and are actually serviced by the original borrowers. However, as contracted, an equalization payment is provided to the company with the net lower interest rate for the payment period.
E) An informal agreement takes place where an electronic funds transfer is established between the banks of AAA and BBB. The fixed terms and repayment schedule of AAA's debt is serviced out of BBB's account, and AAA's account provides the payments subject to the variable rate negotiated by BBB. This arrangement can be terminated by either party.

Question 15

A company has 16 million common shares outstanding and on Dec. 31st, declared a year-end net income after tax of $48 million. It pays a fixed dividend of $1.20 on its 4.8 million preferred shares outstanding. The company's has expanded rapidly and traded steadily at a price/earnings ratio of 32. Four years ago, it issued $42 million worth of debt at 4% compounded annually with a convertible feature that could be exercised December 31st of year 4 of the loan at a price of $84.00. If the company issues new shares to the bondholders, what is the dilution in current earnings per share if maximum conversion occurs?

A) No dilution as the current market price of the share is too low for conversion to take place.
B) Earning per share will drop by 8.0 cents per share after full conversion.
C) No dilution as the current market price of the share is too high for conversion to take place.
D) No dilution will occur as the liquidation of the loan through conversion will boost net income after tax.
E) Earnings per share will drop by 9.1 cents per share after full conversion.

Question 16

Holdean Property Development Ltd. has been downgraded to a BB rating (below investment grade) by the major debt rating agencies. What is the immediate consequence of the reclassification?

A) The company's shareholders are demanding a higher dividend payout.
B) Current bond holders are experiencing a decline in the value of the company's bonds.
C) Current bond holders are requiring and receiving a higher coupon payment on the company's bonds.
D) Holdean Property Development Ltd. has a higher weighted average cost of capital.
E) Banks and financial institutions are legally empowered to step in and restructure Holdean's debt.

Question 17

Doreland Corp. borrowed $3.5 million seven years ago at a floating rate of 5% compounded annual with annual interest payments and principle payable in full at maturity. It also purchased, as part of the loan package, a hedge for $80,000 that limited their rate movement exposure to 2%. Two years after the loan was initiated, interest rates rose by one percent and went up a further one percent, a year later. Rates then stayed the same until 12 months before maturity when they went up by 2%. At the time Doreland took out the loan it chose not to take the alternative of a fixed rate of financing at 7% for the full term of the loan. Ignoring the time value of money, what was the net effect of Doreland's choice of financing compared to locking in a 7% fixed rate of interest?

A) Cost the company $80,000
B) Cost the company $235,000
C) Saved the company $95,000
D) Saved the company $175,000
E) Cost the company $761,158

Question 18

Raven Corporation has 4.8 million shares, 20% of which are cumulative preferred paying a fixed 5% of the $20 face value of the shares. The rest are common shares. Because of loan covenants, the company is restricted to paying out a maximum of 24% of its annual net income after tax in dividends or any dividends if after tax profit drops below $4.5 million. Over the past four years Raven has had net income after tax of $8 million, $6 million, $3 million, $6 million. What is the total value of dividends paid out to common shares in the past four years if the company tries to achieve a maximum payout?

A) $960,000
B) $1.2 million
C) $1.44 million
D) $2.16 million
E) $2.32 million

Question 19

What is the most common purpose for which junk bonds are used?

A) To finance hostile takeovers.
B) By investors who require an instrument that falls between debt and common shares in terms of risk and return.
C) To finance reverse take-overs, where a smaller business is acquiring a larger one.
D) By investors who require a high return option for portfolio diversification.
E) To finance a business whose credit is below an investment grade rating.

Question 20

Emmilou's Designs, a Canadian exporter, operates in international currencies to transact business on both sides of the Atlantic and so, at a time when the Canadian dollar (CAN) was at $0.97 of the US dollar (USD) and the Euro was trading at .625USD, Emmilou Designs issued 5-year Eurobonds which provided them with the equivalent of $5,000,000CAN. At maturity, the Canadian dollar was worth $1.01USD and the Euro at 0.635USD. What was the financial impact of the exchange rates, in Canadian dollars, in the repayment of the face value of the Eurobonds at maturity?

A) Cost $50,000
B) Saved $192,756
C) Saved $121,188
D) Saved $2.9 million
E) Cost $4.6 million

Question 21

Which of the following actions represents the best way to improve a company's finances in the short term?

A) Raise selling prices by 10%.
B) Allow customers 5 days longer to pay.
C) Pay vendors 5 days earlier than before.
D) Decrease union wages by 3%.
E) Carry less 5% less inventory.

Question 22

Comfort Corporation offer its customers payment terms of a 2% discount if they pay in the first 10 days of receiving the invoice or paying the net amount up until 45 days after receipt. If a customer has the option of borrowing from the bank to pay the invoice right away at what interest rate on the borrowings will it make no difference to take the discount or to borrow the money?

A) 21.34%
B) 12.65%
C) 23.45%
D) 44.61%
E) 18.56%

Question 23

Which of the following investments would investors generally view as the riskiness?

A) Bonds.
B) Mortgages.
C) Preferred shares.
D) Common shares.
E) Leases.

Question 24

Which of the following can a business use a credit note to advantage rather than increasing accounts receivable?

A) As security to take out a loan but cannot use accounts receivable in this way.
B) Against the company's own accounts payable as most suppliers will accept a third party note in lieu of cash but not accounts receivable.
C) To deposit the payment in a savings account at par but receive no interest on the amount until the note is collected.
D) To receive cash at the bank at a discount from its face value.
E) To avoid collections as, on the date the note is due, the bank will automatically transfer funds from the account of the borrower into the note holder's account.

Question 25

Which form of long-term financing, if available, is usually used before any other?

A) Debt
B) Common shares
C) Preferred shares
D) Retained Earnings
E) Leases

Question 26

Cameron Financial Corporation provides auto dealerships in its region with a direct loan program to be made available to the purchasers of cars and trucks. In addition to normal consumer loan obligations, each loan also has a lien against the purchased vehicle which serves as collateral for the loan. The loans which Cameron provides are then packaged together and are sold to investors. What is the name for the sale of this type of investment package?

A) Asset-backed bond issue.
B) Loan leveraging.
C) Subordinate financing.
D) Meta-financing.
E) Securitization.

Question 27

A piece of capital equipment which a company needs for the next three years will cost $150,000 to purchase, with residual value of $50,000. The company can finance the purchase with a loan at 8% requiring quarterly payments. Alternately, the company can undertake a capital lease for the same machinery at $11,494 a quarter and a promise to return the machine at a value of $50,000. Why might the company choose the leasing alternative over the purchase alternative?

A) The NPV of the leasing option is higher than the purchase option.
B) The lease is capitalized, presenting a greater tax write-off than the loan and, therefore, a lower overall cost.
C) The company would have legal control of the asset, how it is used and maintained and its disposal.
D) Lease payments present a lower cash outflow per month than the purchase.
E) The interest being charged on the lease is lower than on the loan.

Question 28

What provides the borrower the most flexibility in terms of paying for its financing?

A) Factoring, as the full amount of the investment will change depending on the amount of accounts receivable being sold
B) Common share equity financing, as the payment of dividends is at the discretion of the board of directors
C) Debenture financing as the repayment can be suspended for up to five years
D) Bond financing due to the extendable feature allowing the term to be increased by up to 25% of the original length
E) Bank borrowings, as the terms of any loan can be renegotiated depending on the performance of the company

Question 29

What has been the most popular way of obtaining new financing by Canadian businesses in recent years?

A) Bonds.
B) Common shares.
C) Leases.
D) Sale-and-leaseback arrangements.
E) Securitization of assets.

Question 30

Great Systems Inc. (GSI), a publicly-traded company, needs $30 million additional financing to repair its balance sheet and to expand into the cloud computing infrastructure market. Somes of GSI's balance sheet classification amounts, in millions, are as follows: Current assets $10; Property, plant, and equipment $90; Current liabilities $30; Long term liabilities $35; retained earnings 10. How should GSI raise the needed $30 million?

A) Issue 15 year bonds
B) Issue preferred shares
C) Issue common shares
D) Issue a mortgage on the property
E) Issue a strip bond

Question 31

A company seeks a one-time loan on 75% of the face value of its accounts receivable outstanding and must pay within 60 or 90 days regardless of whether it has collected its receivables. What type of financing is the company seeking?

A) Accounts receivable factoring.
B) Receivables discounting.
C) A credit note.
D) Working capital monetization.
E) Monetizing receivables.

Question 32

Binder Inc's credit sales are projected to be $11,680,000 for the year. The company collects its receivables over an average period of 50 days and finances them by borrowing on its bank line of credit at an interest rate of 9%. Management has determined that if it hires another clerk in the receivables department at $32,000 per year, it can reduce average days outstanding for the receivables to 30, the industry average. What should Binder Inc do?

A) Hire the clerk and achieve a net savings of $86,400.
B) Hire the clerk and achieve a net savings of $54,400.
C) Do not hire the clerk as the net cost is $28,260.
D) Do not hire the clerk as the net cost is $3,740.
E) Hire the clerk and save $123,733.

Question 33

Henning Fulfillment Ltd. is an outsourcing company that packages and delivers the prizes and premiums awarded from company contests, charitable lotteries and mail-in sweepstakes. As a solution to its temporary liquidity problem it undertook a sale-and-leaseback arrangement with a financial institution with respect to its main warehouse. What may Henning?

A) The cost of the lease is higher than if the assets were leased in the usual way.
B) The leasing costs cannot be written off as an expense.
C) If the warehouse is sold, Henning may not benefit from any capital appreciation of the asset but may be subject to a tax liability for capital gain.
D) Henning will not be allowed to vacate the premises after a specified term as the lease arrangement is subject to being continuously rolled forward by the lessor.
E) Once the lease cost is established Henning will have no opportunity for rent review if property values, property tax or interest rates drop significantly.

Question 34

Which of the following best describes recourse factoring?

A) The company, not the factor, assumes the financial loss for bad debts arising from credit sales.
B) Uncollectible accounts are covered by insurance. The insurance company keeps any amounts that it may recover from its own collection efforts.
C) For an additional fee, the factor assumes responsibility for collecting an agreed upon amount of bad debts but has no legal rights to act against the debtor.
D) The factor takes responsibility for bad debts and is legally entitled to pursue the debtor through the courts.
E) The initial factor bundles the bad debt contracts and sells them for a deep discount to a subcontractor.

Question 35

Which of the following is an example of an appropriate matching of sources of funds with uses of funds?

A) Financing an expansion of accounts receivable with bonds
B) Purchasing a truck fleet using accounts receivable discounting
C) Financing a decrease in accounts payable with debentures
D) Financing an operational plant expansion using factoring
E) Purchasing new equipment with a term loan

Question 36

Gamesoft Inc. has $100 million in annual credit sales that take an average of 40 days to collect. to meet Gamesoft's cash flow problems it maintains a floating loan at 10% interest. Gamesoft says they are indifferent to factoring their receivables at a 3% fee. The factor would advance 70% of the receivables at 8% interest, would cut the collection period down to only 30 days, and eliminate all bad debts. What is the amount of Gamesoft's bad debts that exist by collecting the receivables on its own?

A) $246,575
B) $460,274
C) $1,095,890
D) $2,610,959
E) $3,000,000

Question 37

Comfort Ltd. offers customers payment terms on invoices of 2/10, n30. A customer is unable to pay the invoice when received but will have the funds by month end. The customer has the option of borrowing on its 12% line of credit and paying off the invoice or waiting until the end of the 30 days. What should the customer do?

A) Borrow the funds on the tenth day and pay the invoice.
B) Borrow the funds upon receipt of the invoice and pay immediately.
C) Borrow the funds upon receipt and pay in 30 days.
D) Wait until the end of the month and pay from the customer's own cash.
E) Wait until month end to borrow the funds and pay the invoice.

Question 38

What does it mean when an investor says she has invested in a twenty-year zero-coupon bond?

A) The investor is not receiving any return but the principal is safe for the period.
B) The investor does not have to be concerned about investing the interest payments.
C) The yield to maturity floats up and down with prevailing rates over the life of the bond.
D) The investor receives direct deposits of annual interest payments without clipping coupons.
E) The investment is locked in for the twenty year period because the investor cannot sell the bond.

Question 39

Greenland Dairy has annual credit sales of $29.2 million. The company's collection period is 45 days. The company has been financing its receivables with a bank overdraft at 17%. A proposal from a factoring business offers a cash advance of 80% of receivables at an interest rate of 14%. Further, the factor expects to collect all receivables within 40 days and charge 2% of collections. Greenland will save $50,000 in collections administration. Which of the following will the factoring arrangement do?

A) Save the company $14,000
B) Cost the company $14,000
C) Cost the company $389,200
D) Save the company $130,800
E) Save the company $239,000

Question 40

Rocket Potassium Ltd. has $15 million in credit sales per year and on average they are outstanding for 75 days. Each rocket dosage sells for $1,000 and results in a 10% contribution margin. Receivables are financed at a 12% interest rate. Bad debts total $350,000 annually. The accounting department has a new plan by which it estimates it can eliminate half of the bad debts and reduce the collection period by 30 days if it is permitted to hire two collections specialists at a cost of $85,000 per year each. The new plan would result in 2% lost sales. How much better off would the new plan leave Rocket Potassium?

A) $122,384
B) $127,384
C) $157,384
D) $297,384
E) $302,384

Question 41

Which of the following best describes the pecking order theory?

A) Dividend are preferable to capital gains.
B) Capital gains are preferable to dividends.
C) Retained earnings are preferable for long term financing.
D) Debt is preferable for long term financing.
E) Common shares are preferable for long term financing.

Question 42

What is the equivalent annual interest rate for purchase made with discount terms of 1/10/n75?

A) 3.52%
B) 5.81%
C) 7.69%
D) 15.43%
E) 44.35%

Question 43

Saskatchewan Potash Ltd. has $20 million in credit sales per year and on average they are outstanding for 55 days. Potash sells for $1,000 per ton and results in a 20% contribution margin. Receivables are financed at a 10% interest rate. Bad debts total $600,000 annually. The accounting department has a new plan by which it estimates it can eliminate three-quarters of the bad debts and reduce the collection period by 25 days if it is permitted to hire one collections specialists at a cost of $105,000 per year. Some sales would be lost due to credit tightening under the new plan. By what percentage would sales have to decline to leave Saskatchewan Potash Ltd. indifferent between the two alternatives.?

A) 12.57%
B) 13.57%
C) 14.57%
D) 15.57%
E) 16.57%