Module Five Homework
1) Define at least two common credit agreement provisions (loan covenants).
Lenders use covenants to protect themselves against borrowers defaulting on their obligations
as a result of financial actions that are detrimental to themselves or the business.
Insurance against natural disasters / Insurance against personal belongings
Insurance on the plant / equipment or inventory is required by law, and the borrower is
responsible for maintaining this coverage in order to protect against catastrophic loss of
collateral.
Information about the borrower's and guarantor's financial situation
oThe borrower agrees to submit financial statements to the bank for the purpose
of the bank's ongoing assessment. The submission of financial statements is
usually done once a year, whereas the submission of accounts receivable can be
done every month.
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.
Long Term Liabilities
Note payable with total balance due in 5 years
Mortgage loan with payment made monthly over 5 years
Current Liabilities
Accounts Payable
Accrued Liabilities
3) What are the three components of the cost of capital?
Common Stock
Preferred Stock
Debt
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?
$2,000,000 x (9% x (1- 15%) = $153,000
Calculate the cost of issuing preferred stock using the same information above.
What is the preferred stock interest cost?
$2,000,000 x 9% = $180,000
5) What are some reasons a company would chose not to offer cash dividends? What impact might
this have on the business operations?
It is possible that a company will choose not to pay cash dividends in order to reinvest its
earnings in the company's growth. If a company is experiencing low cash flow, it may be
necessary for them to retain the earnings, or withholding cash dividends may be standard
industry practice for the organization. It is possible that withholding cash dividends from their
shareholders will either improve or cause their business operations to fail. Example: If
shareholders are expecting dividend payments and the company does not pay them, these
investors may begin to pull their money out of the company, resulting in a significant reduction
of funds for the company. However, a company that retains its earnings for future growth, with
its shareholders understanding and supporting business operations, may see a significant
increase in revenue, as well as a significant increase in future returns to shareholders.
