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Unformatted text preview: Chapter 8 Discussion Questions 8-1. Under what circumstances would it be advisable to borrow money to take a cash discount? It is advisable to borrow in order to take a cash discount when the cost of borrowing is less than the cost of foregoing the discount. If it cost us 36 percent to miss a discount, we would be much better off finding an alternate source of funds for 8 to 10 percent. 8-2. Discuss the relative use of credit between large and small firms. Which group is generally in the net creditor position, and why? Larger firms tend to be in a net creditor position because they have the financial resources to be suppliers to credit. The smaller firm must look to the larger manufacturer or wholesaler to help carry the firms financing requirements. 8-3. How have new banking laws influenced competition? New banking laws allowed more competition and gave banks the right to expand across state lines to create larger, more competitive markets. They also increased bank mergers. 8-4. What is the prime interest rate? How does the average bank customer fare in regard to the prime interest rate? The prime rate is the rate that a bank charges its most creditworthy customers. The average customer can expect to pay one or two percent (or more) above prime. 8-5. What does LIBOR mean? Is LIBOR normally higher or lower than the U.S. prime interest rate? LIBOR stands for London Interbank Offered Rate. As indicated in Figure 8-1, it is consistently below the prime rate. S8-1 8-6. What advantages do compensating balances have for banks? Are the advantages to banks necessarily disadvantages to corporations? The use of a compensating balance or minimum required account balance allows the banker to generate a higher return on a loan because not all funds are actually made available to the borrower. A $125,000 loan with a $25,000 compensating balance requirement means only $100,000 is being provided on a net basis. This benefit to the lender need not be a disadvantage to the borrower. The borrower may, in turn, receive a lower quoted interest rate and certain gratuitous services because of the compensating balance requirement. 8-7. A borrower is often confronted with a stated interest rate and an effective interest rate. What is the difference, and which one should the financial manager recognize as the true cost of borrowing? The stated interest rate is the percentage rate unadjusted for time or method of repayment. The effective interest rate is the true rate and considers all these variables. A 5 percent stated rate for 90 days provides a 20 percent effective rate. The financial manager should recognize the effective rate as the true cost of borrowing. The effective rate is also referred to as the APR (Annual Percentage Rate)....
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This note was uploaded on 04/10/2011 for the course ADM 474 taught by Professor Stewart during the Spring '10 term at Indiana Wesleyan.
- Spring '10