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).
When it comes to two common credit agreements provisions one might find there is the Current Ratio Requirement which is a requirement ratio that is a measure of cash flow of the ability of the borrower to successfully deal with debt obligations that are levied onto them.
The other common credit agreement provision is Minimum Working Capital which in normal terms is talking about how a company will keep some working capital on hand to maintain operations around the facility should anything happen. You can think of it as a safety cushion should anything happen outside of company parameters.
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- This is under the classification of current liabilities. Accrued Liabilities- This is under the classification of current liabilities. Notes Payable with a total balance due in 5 years-This is under the classification of long. term liabilities due to the fact it's over a period of time and not actively being paid on. Mortgage Loan with Payments Made Monthly Over 5 Years- This is under the classification of current liabilities as the payments are being made actively over a monthly period of time.
3) What are the three components of the cost of capital?
Debt- A commitment to return money owed to a lender over a series of payments overtime that may also accrue interest depending on the lender's agreement with the borrower. Preferred Stock- Equity that stockholders are issued with a fixed interest rate Common Stock- Funding that is issued out by a corporation without the requirement to pay stockholders dividends for common stock take back as this gives them leverage in company policy should they be part of a board of directors.
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.
Southern New Hampshire University What is the after-tax cost of debt? 153,000
Calculate the cost of issuing preferred stock using the same information above
What is the preferred stock interest cost? 180,000
Using the information above, what are the advantages and disadvantages of both
methods?
After-Tax Cost of Debt: Pros to using this method are being able to have a deductible
interest on any loss of net income accrued over the year that can be used to save on tax
liabilities for the next year. The only Con with this method is the fix interest rates for debt
repayment that some investors might not be too happy about paying on. This usually has
to be addressed with giving discounts to the investors which also means less operational
cash to use.
Preferred Stock interest: Starting with the massiv