ACC 340 Module Five Homework

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School

Southern New Hampshire University *

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340

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Finance

Date

Jan 9, 2024

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Module Five Homework Respond to each and then upload your responses. 1) Define at least two common credit agreement provisions (loan covenants). a. The current ratio requirement is a common credit agreement provision. This method finds the current ratio by dividing current assets by current liabilities to determine the creditworthiness of the borrower. This method allots a minimum requirement to determine qualification. This ensures that if the company defaults on the loan the lender can receive the money owed by liquidation of assets. b. The minimum working capital requirement subtracts the company’s assets from liabilities. This explains to the lender what funds are available day-to-day. This information confirms that the company can effectively repay the loan. This is also used to set a requirement that working capital must stay at or above a certain amount to ensure long term repayment security. 2) Classify the following as long term or current liabilities: Accounts Payable, Accrued Liabilities, Note Payable with total balance due in 5 years, Mortgage Loan with payments made monthly over 5 years. a. Accounts Payable are considered a current liability because they are short-term accounts that the company will quickly repay, typically within the month’s end. b. Accrued liabilities are also considered a current liability. These accounts will typically be repaid within one year. c. Notes payable with total balance due in five years are long-term liabilities. d. Mortgage loan with payments made monthly over five years are considered long-term liabilities because they will be repaid in longer than a year. 3) What are the three components of the cost of capital? a. The first component of the cost of capital is debt. This includes the interest owed to the lender, as well as the principle. This is typically shown as a percentage. This component can change based on interest rates and on-time payments made by the company. b. The second component of the cost of capital is preferred stock. This is an interest rate that company’s are required to pay to stockholders. c. The third component is common stock. This is the highest component of the three. While there is no payment schedule in place, investors receive dividends. This is an important component because the return on the investment could influence future investments. The dividends paid give investors incentives to invest in the future.

4) Calculate the after tax cost of debt using the following information (hint: see page 285 in text). A company issues $2 million at 9% interest with a 15% tax rate. What is the after-tax cost of debt? a. After-tax cost of debt = 2000000 * (.09 * (1-.09)) = $163,800 Calculate the cost of issuing preferred stock using the same information above. What is the preferred stock interest cost? a. Preferred stock interest cost = 2000000 * .09 = $180,000 Using the information above, what are the advantages and disadvantages of both methods? a. The advantages of debt include tax-deductible payments, maintaining ownership of the company, and the debt is repaid at a constant rate. b. Disadvantages of debt include long-term payments that will still require repayment if the company faces financial hardship. Too much debt can harm the company, and debt holders will liquidate assets if bankruptcy is filed. c. Advantages of preferred stock include the lack if regular payments, in the case of bankruptcy, preferred stockholders can access the assets of the company before common stockholders and does not sacrifice voting power. d. Disadvantages include no tax deductions on payments, sacrifice of full ownership, and is typically less attractive to investors because of the lack of repayment. 5) What are some reasons a company would chose not to offer cash dividends? What impact might this have on the business operations? a. Companies can choose not to offer cash dividends if reinvesting the money would be more beneficial for long-term operations. This is especially applicable if there are opportunities for the company to grow and expand. These funds will assist in financing the new opportunities rather than going back into the pockets of investors. This is based on the idea that withholding the dividends now will lead to a significantly greater return in the future. The company may also choose to use the funds to lower the amount of debt owed, as this would increase the value of the company and could increase dividends in the future. The company could also be interested in becoming stronger financially and would need the funds to be better prepared for unpredictable financial hardships.

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