Southern New Hampshire University
Module Five Homework
Respond to each and then upload your responses.
1) Define at least two common credit agreement provisions (loan covenants). Current Ratio Requirement- this requirement ratio is how the cash flow is measured and it gives the reflection of the borrower's ability in being able to successfully service the borrower's debt obligations. Minimum Working Capital- With this the company covenants assures that to make sure the company operating cash needs are kept and maintained with a fixed amount of working capital.
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.
Accounts Payable- They are under the classification of a current liabilities
Accrued Liabilities- They under the classification of a current liabilities.
Notes Payable with a total balance due in 5 years-They are under the classification of long-term liabilities.
Mortgage Loan with Payments Made Monthly Over 5 Years- they are under the classification of current liabilities.
3)What are the three components of the cost of capital?
with a series of payments over a certain time.
Common Stock- Funding given by the company without having a requirement to pay stockholders dividends for common stock take back.
Preferred Stock- Equity that stockholders are issued with a fixed interest rate.
Southern New Hampshire University
4) Calculate the after tax cost of debt using the following information (hint: see page 285 in text).
A company issues fl2 million at 9% interest with a 15% tax rate.
What is the after-tax cost of debt? fl153,000
Calculate the cost of issuing preferred stock using the same information above.
What is the preferred stock interest cost? fl 180,000
Using the information above, what are the advantages and disadvantages of both methods?
After-tax cost of debt:
Advantages: Deductible Interest
The company's net losses can be carried forward to the next reporting
period. The accumulated losses help future earnings avoid tax
liabilities.
Disadvantages: If the company uses a fixed interest rate on its debt, investors
could become uncooperative in purchasing the debt unless they are given a
significant discount. This leaves the company with less operating cash.
There could be significant extra fees that the company is not prepared to handle.
Preferred Stock:
Advantages: A understanding in a stock agreement that describes common
stock is set at a determined fixed price could eliminate interest payments.
Stockholders are not paid back their original investment to the company. Debt is
periodic payment of the principle on the original investment.
Disadvantages: Using preferred stock is much more expensive.
Southern New Hampshire University
5) What are some reasons a company would chose not to offer cash dividends? What impact might this have on the business operations?
Not paying dividends could make the company less attractive to investors.
A company that is growing at rapid pace wants to reinvest as much as possible to continue growing