Southern New Hampshire University
Module Five Homework
Respond to each and then upload your responses.
1) De ne at least two common credit agreement provisions (loan covenants) Debt: This states that the company and its subsidiaries will not incur or guarantee any addi onal debt than what was originally borrowed Minimum working capital: the company covenants that it will maintain a xed amount of working capital to cover the amount of opera ng cash that the company needs
2) Classify the following as long term or current liabili es: Accounts Payable, Accrued Liabili es, Note Payable with total balance due in 5 years, Mortgage Loan with payments made monthly over 5 years.
Classi ed as Long-term liabili es:
Note payable with total balance due in 5 years
Classi ed as Current Liabili es:
Accounts Payable Accrued Liabili es Mortgage loan with payments made monthly over 5 years
3)What are the three components of the cost of capital? The three components of the cost of capital are debt, preferred stock, and common stock. Debt is the company's commitment to repay both interest and principal. Preferred stock is a form of equity that is issued to a company's stockholder's who get a speci c interest rate compared to common stockholders. Common stock is stock that a company is not obligated to pay dividends to, and is the least risky op on of nancing
4) Calculate the a er-tax cost of debt using the following informa on (hint: see page 285 in text).
A company issues $2 million at 9% interest with a 15% tax rate.
What is the a er-tax cost of debt? $153,000
Debt cost = principal * ((interest rate * (1 -- tax rate))
Debt cost = 2,000,000 * ((.09 * (1-.15))
Debt cost = 2,000,000 * (.0765)
Debt cost = $153,000
Southern New Hampshire University
Calculate the cost of issuing preferred stock using the same informa on above.
Preferred Stock interest cost = Principal * interest rate
Preferred Stock interest cost = 2,000,000 * .09
Preferred Stock interest cost = $180,000
What is the preferred stock interest cost? $180,000
Using the informa on above, what are the advantages and disadvantages of both methods?
Debt Cost Advantages:
Interest expense is tax deduc ble
Any net loss will carry forward into the next repor ng period
Debt Cost Disadvantages:
Hidden fees
With se ng xed interest rates, it could lead to borrowers wan ng a discount so that
they can increase the interest rate they will earn on the debt
Preferred Stock Advantages:
Does not require repayment to the shareholder of the amount paid for each share
Some shares carry provisions that allow delayed interest payments to be cumula ve so
that they must be paid before dividends are paid out
Preferred Stock Disadvantages:
Interest expense is not tax deduc ble
More expensive than the debt cost method
5) What are some reasons a company would chose not to o er cash dividends? What impact might this have on the busi