Question

26.)What would be the monthly payment on a 5 year loan of $24,000 if the interest rate is 5.0% compounded montly?

	A.	$452.91
	B.	$492.75
	C.	$377.42
	D.	$500.00

true or false:

27.)When doing a comparison of ratios for your company, the comparison probably should be with the industry average.

28.)When taking out a loan you would rather get an interest rate of 7% compounded monthly, instead of one compounded daily.

29.)Which of the following financial ratios are market-based ratios?

	A.	debt-to-equity
	B.	price-to-earnings
	C.	return on investment
	D.	gross profit margin

30.)Window dressing is:

	A.	Retailers advertising in windows.
	B.	Making your books look better by "Cooking the Books".
	C.	Calculating the interest rate needed to double your money.
	D.	Is legal and ethical.

Answer 1

26. Monthly payment:

Loan term = 5 years; number of compounding periods = 5 * 12 = 60 months

Loan amount = 24,000; interest rate = 5%; monthly interest rate = 5% /12 = 0.4167%

24,000 = C/(1+0.004167)^1 + C/(1+0.004167)^2 + C/(1+0.004167)^3 + .... + C/(1+0.004167)^59 + C/(1+0.004167)^60

Solving for C, we get C = $452.91

27. Ratio analysis

True. Comparing ratios of the company with the industry average as the benchmark is preferred method to understand the performance and profitability of the company.

28. Taking loan

Effective Annual interest rate helps in comparing different nominal rates, compounded for varied terms. Formula: [1 + EAR] = [ 1 + i/m ] ^ (m * n )

m = frequency of compounding; n = term; i = stated annual rate

For, $1 loan for 7% p.a for 1 year, compounded monthly will have an effective annual rate as:

• Here, i = 7%, m = 12, n = 1. EAR is calculated as:
• 1 + EAR = [ 1 + 0.07/12 ] ^ (12 * 1 )
• 1 + EAR = [ 1 + 0.005833] ^ 12
• 1 + EAR = 1.07229
• EAR = 1.07229 - 1 = 0.07229 = 7.229%

For $1 loan for 7% p.a for 1 year, compounded daily will have an effective rate as:

• Here, i = 7%, m = 365. EAR is calculated as:
• 1 + EAR = [ 1 + 0.07/365 ] ^ (365)
• 1 + EAR = [ 1 + 0.000192] ^ 365
• 1 + EAR = 1.072501
• EAR = 1.072501 - 1 = 0.072501 = 7.2501%

Interest on monthly compounded rate is higher than that of the monthly compounding. Hence, monthly compounding choice is preferred to that of daily compounding.

29. Market-based ratios are used to evaluate the price of the company to determine if price is over-values or under-valued.

Debt/Equity ratio gives an idea of capital structure. Market value of Debt and Market value of equity is considered to understand the current Debt/equity ratio. Hence D/E is market-based ratio.

Price/Earnings ratio: Current market price is used to find the P/E ratio. This is also a market-based ratio.

Return on Investment: It is calculated by taking beginning and ending values during a period, stated as capital gain and divided by the beginning value of the period. Valuation is based on the time period, so ROI is also market-based ratio.

Gross Profit Margin (GPM) is Gross Profit / Sales. There is no market related variable in the ratio, Both the gross profit and sales are obtained from the income statement and not related to any price or investment factor. Hence it is not a market-based ratio.

30. Window dressing:

Window dressing is misleading representation of something that is not performing well when compared to the average. It is used in financial terms, as manipulating books of accounting and project as if the company's performance is superior, when in actual, the firm might be loss-making. Answer: option (B) Making your books look better by "Cooking the books'"