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 Fundamentals of Financial Summary of Results
Management, twelfth edition
 !"  of 20 Scored items:
  
 Fundamentals of Financial
5 Correct: 25%
Management, twelfth edition
15 Incorrect: 75%
  Van Horne/Wachowicz

 
 More information about scoring

    Student Resources > Chapter 21

 
 > Multiple choice questions
  July 27, 2010 at 1:50 AM (EDT)

 


#$ A __________ is charged by the lender to hold credit open for the
borrower. For example, if the firm only uses $100,000 of a $200,000
limit, then the firm might pay the lender $500 for the unused limit in
addition to the interest on the amount borrowed.

c
%
revolving credit agreement
" %
commitment fee


Incorrect. This refers to a commitment fee. A revolving credit agreement

allows the borrower to have credit up to some maximum amount over a
specific period, but allows the company to renew or borrow additionally.

$ __________ lease is a lease where the lessee maintains and insures the
leased asset rather than the lessor in a full-service lease.

c
%
An operating
" %
A net


Incorrect. This refers to a net lease. An operating lease refers to a short-

term lease that is often cancelable. For example, a lease for office space
represents this type of lease where the lease life is less than the useful
life of the asset.
$ Your firm currently has a current ratio of 1.90 on $9.5 million of current
assets. You are changing the financing mix of your firm and plan on
converting financing of $1,000,000 in a 6-month loan into a 5-year term
loan. The purpose of this move is to finance a more permanent portion of
inventories with a longer maturity alternative. If the firm issues the term
loan, new restrictive covenants will require that the current ratio remain
at or above 2.00. Should the firm make this change or is there some
obvious problem caused by this proposed change?

c
%
Yes

Correct.

&$ A __________ represents any restriction imposed on a borrower by a

lender and would be part of the loan agreement.

c
%
loan agreement
" %
covenant


Incorrect. This refers to a covenant. A loan agreement would include

covenants and specifies all of the terms of a loan and the obligations of
the borrower.

$ Einstein Neutron Company wants to acquire a new atom-smashing

machine at a cost of $1 million that will have a nine-year useful life. The
asset falls into the seven year MACRS property class for depreciation
purposes. At the end of its useful life, the firm anticipates a residual
value of $200,000. The firm can borrow the funds needed with a seven-
year loan amortized at 14% annually (payments include both principal
and interest and are paid at the beginning of each year). There is lease
financing available at a cost of $150,000 annually (all nine years) due at
the beginning of each year. Assume that the firm is in a o
 

 
. Which type of financing is preferred? How much of an
advantage does that type of financing have over the other type?

c
%
hease financing; less than $50,000
" %
Debt financing; less than $50,000


Incorrect. The present value of leasing costs are $586,788 while the
present value of debt financing costs are $579,428 due to the 40% tax
rate.

A$ What is the commitment fee that will most probably be charged to the
firm for the m
 given the following information? The firm has just
signed a three-year revolving credit agreement that has a $5 million
 maximum loan limit. The firm is borrowing $1 million today at 10 percent
annual interest for the next year with a commitment fee of 0.4 percent.
It does not anticipate borrowing any additional funds for the first year.

c
%
$16,000

Correct.

'$ A __________ is a continuously offered debt instrument that is designed

to fill the gap between commercial paper and long-term bonds with
maturities currently ranging from 9 months to 30 years and has gained
favor from the existence of shelf registration.

c
%
term loan
" %
medium-term note


Incorrect. This refers specifically to a medium-term note -- a type of

term loan. A term loan is generally considered debt that is repaid
between 1 to 10 years under a formal loan agreement and is usually
amortized (principal and interest are paid) in equal periodic installments.

Ë$ A __________ forbids the future pledging or mortgaging of any of the

borrower's assets.

c
%
covenant
" %
negative pledge clause


Incorrect. This refers to negative pledge clause. A covenant is broader

and represents any restriction imposed on a borrower by a lender.

*$ __________ lease refers to a short-term lease that is ‘m

 cancelable.
For example, a lease for office space represents this type of lease where
the lease life is less than the useful life of the asset.

c
%
None of the above answers are correct.
" %
An operating


Incorrect. This refers to an operating lease.

#($ Which of the following is ‘

a type of financial lease arrangement?

c
%
All of the above answers are types of financial lease
 arrangements.
" %
Indirect leasing


Incorrect. Sale and leaseback,


leasing, and leveraged leasing
represent the types of financial leases.

##$ For a company subject to the alternative minimum tax (AMT),

__________ is a "tax preference item," whereas __________ is not.
Such a company may prefer to __________.

c
%
accelerated depreciation; a lease payment; lease

Correct.

#$ Einstein Neutron Company wants to acquire a new atom-smashing

machine at a cost of $1 million that will have a nine-year useful life. The
asset falls into the seven year MACRS property class for depreciation
purposes. At the end of its useful life, the firm anticipates a residual
value of $200,000. The firm can borrow the funds needed with a seven-
year loan amortized at 14% annually (payments include both principal
and interest and are paid at the beginning of each year). There is lease
financing available at a cost of $150,000 annually (all nine years) due at
the beginning of each year. Assume that the firm is in a K
 

 
. Which type of financing is preferred? How much of an
advantage does that type of financing have over the other type?

c
%
hease financing; less than $50,000

Correct.

#$ A __________ allows the borrower to have credit up to some maximum

amount over a specific period, but the notes are usually 90 days and
allow the company to renew or borrow additionally.

c
%
medium-term note
" %
revolving credit agreement


Incorrect. This refers to a revolving credit agreement. A medium-term

note has maturities currently ranging from 9 months to 30 years and
gained favor from the existence of shelf registration.

#&$ What is the

‘
  ‘
(including interest charges) that will be charged to
 the firm for the m
 for the decision to enter into the revolving
credit agreement? The firm has just signed a three-year revolving credit
agreement that has a $5 million maximum loan. The firm is borrowing $1
million today at 10 percent annual interest for the next year with a
commitment fee of 0.4 percent. It does not anticipate borrowing any
additional funds for the first year.

c
%
$100,000
" %
$116,000


Incorrect. The firm must pay 4/10 of 1% of the $4 million of unused

credit. This is $16,000 during the first year. In addition, the firm will pay
$100,000 in interest charges for a total of $116,000.

# $ Your firm currently has a current ratio of 2.10 on $5 million of current

liabilities. You are financing a $500,000 machine (fixed asset) and
$500,000 of additional inventories with a 5-year term loan. Alternatively,
the firm can finance the additions with a 6-month loan that they will need
to get approval to renew every six months. Existing restrictive covenants
require that the current ratio remain at or above 2.00. Which alternative
will keep the current ratio above 2.00?

c
%
Both of the loans would keep the current ratio above
2.00.
" %
5-year term loan.


Incorrect. Current assets are $10.5 million and current liabilities are $5
million. The new ratio would be $11 million divided by $6 million that
equals 1.83 under the 6-month loan.

#A$ With a capital lease, the amount recorded on the asset side of the
balance sheet is __________.

c
%
the present value of the maximum lease payments
over the lease period
" %
the present value of the minimum lease payments
over the lease period 

Incorrect. The amount recorded is the PV of the minimum lease

payments over the lease period.

#'$ Which of the following statements is most correct as it relates to the

recording of a capital lease?

c
%
A capital lease is listed as an asset on the lessee's
 balance sheet and must be amortized over the
asset's useful life.
" %
A capital lease is listed as an asset on the lessee's
balance sheet and must be amortized over the lease

period.

Incorrect. A capital lease is listed as an asset on the lessee's balance

sheet and must be amortized over the lease period.

#Ë$ A __________ is generally considered debt that is originally scheduled to

be repaid between 1 to 10 years under a formal loan agreement and is
usually amortized (principal and interest are paid) in equal periodic
installments.

c
%
commitment fee
" %
term loan


Incorrect. This refers to a term loan. A commitment fee is charged by the

lender to hold credit open for the borrower.

#*$ A __________ specifies all of the terms of a loan and the obligations of
the borrower.

c
%
loan agreement

Correct.

($ __________ lease is a long-term lease that is ‘

cancelable and its life
often matches the useful life of the asset.

c
%
None of the above answers are correct.
" %
A financial


Incorrect. This refers to a financial lease.