Chapter 14: Bank Management: A few practice problems and some
selected answers to assigned end of chapter questions
1. All of the factors are equally important and interrelated. Without satisfactory answers to each, a lender
has accepted too much risk. Still, lending is heavily tied to an analysis of the borrower’s character. Why
lend if there is a high probability that the borrower is fraudulent or unethical?
2. Collateral is a back-up source of repayment, and should not be used to approve a loan by itself. Loans
granted on the basis of collateral are subject to risk that the collateral is overvalued and the bank might
not be able to control the collateral or obtain clear title.
3. In most cases, a request for loans to buy cheese is unacceptable because this should be financed by
normal cash flows. Also, a loan for the owner to buy a car should be a personal loan and not made to the
business, unless the car will be used for business. Loans to pay employees in a cash crunch are not
generally acceptable because these payments should also come from normal cash flows. A request
would indicate serious problems. The other uses are appropriate in normal circumstances, such as the
purchase of equipment to produce the pizza, a take-out of an existing mortgage, and a loan to buy a
company.
4. Why would anyone lend to an individual with bad character? Similarly, why lend to a firm or non-profit
organization with a bad reputation and senior management officials who have histories of problems?
The only answer is that the lender might be able to control all risk and thereby still earn a return. Still,
borrowers default. Frequently, a borrower who does not want to pay back a loan can find a
reason/justification for not making promised payments. If a borrower (borrowing entity) doesn’t have
the character consistent with repaying debts, the costs of collecting will generally far exceed the nominal
income from the loan.
7. A high current ratio is associated with high cash, receivables and inventory relative to current liabilities.
Consider a case where the high current assets are inventory and receivables. All receivables are more
than 120 days past due (uncollected) because the firm’s customers cannot pay. The inventory is in the
form of finished goods for which there is no known market. The current ratio will overstate liquidity
because the firm cannot effectively sell inventory or collect on receivables.
9. Sources or uses of cash
a. source
b. use
c. no real impact
d. source
e. use
f. use (reports increase in accounts receivable)
g. use
12. Primary source of repayment
a. Selling an asset: advantage: typically a predictable value; disadvantage: time and cost to sell may be
high such that transactions costs are high
b. Generating more sales: advantage: high value for an ongoing concern which should lead to greater
cash flow if operating expenses and cash outflows are controlled; disadvantage: may take some time
to collect on increased sales – did the firm change collection policies and practices? Reported sales
do not necessary reflect net cash inflows.
c. Issuing stock (equity): advantage: lowers financial leverage and firm does not have to pay dividends
immediately; disadvantage: time to issue may be long without a shelf registration
d. Increasing a liability: advantage: predictable and quick to access funds; disadvantage: increases
financial leverage
e. Decreasing expense: advantage: long-term effect if successful; disadvantage: difficult to achieve
during the near term
f. Reducing dividends: advantage: predictable; disadvantage: loss in share price and perceived
stockholder value.
13. Ratios:
a. Current ratio: $1,280/$980 = 1.31X
b. Days accounts receivable = $700/($9,125/365) = 28 days
c. Inventory turnover = $6,100/($500) = 12.2X
d. Days accounts payable outstanding = $400/($6,100/365) = 23.9 days; need to know purchases;
assume that inventory is unchanged for the period. If so, purchases equal cost of goods sold or
$6,100.
e. Long-term debt / equity = $550/$970 = 0.57
f. Times interest earned = ($9,125-$6,100-$2,550)/$101 = 4.7X
g. ROE = $216/$970 = 22.27%
h. $9,125/$2,500 = 3.65X
14.
a. Debt service requirements with prime at 8% (effective rate at 10%) are:
Principal + interest + dividends = Year 1: $500,000 + $150,000 + $140,000 = $790,000
= Year 2: $500,000 + $100,000 + $140,000 = $740,000
= Year 3: $500,000 + $50,000 + $140,000 = $690,000
Cash flow from operations – (principal + interest + dividends)
Year 1 = $750,000 - $790,000 = -$40,000
Year 2 = $780,000 - $740,000 = +$40,000
Year 3 = $800,000 - $690,000 = +$110,000
b. If prime equals 9%, interest payments increase by:
$15,000 in Year 1; $10,000 in Year 2; and $5,000 in Year 3.
Net cash flow in Year 1: -$55,000; Year 2: $30,000; Year 3: $105,000
If prime equals 10%, interest payments increase by:
$30,000 in Year 1; $20,000 in Year 2; and $10,000 in Year 3 with corresponding changes in net
cash flow.
15. A partial list of questions would include:
a. What is the experience level of the firm's officers?
b. If Marcus Wade were to die, who would take over as president?
c. Who are the minority owners?
d. How many people does Wade's employ? Are they unionized?
e. What companies are major suppliers to Wades? Has the firm ever had difficulty obtaining raw
materials? Can the bank inspect the inventory?
f. Why did Wade's sales increase so dramatically in 2008?
g. What is the nature and timing of the firm's production process?
h. How does Wades recognize bad debts and uncollectible receivables?
i. What are Wade's terms on credit sales?
j. Why does Wades not pay dividends?
Chapter 14 Sample Questions: Evaluating Commercial Loan Requests and Managing Credit Risk
1. According to information from the Federal Reserve Board, delinquencies at commercial banks
on “all loans and leases” peaked in ________:
a. 2007
b. 2008
c. 2009
d. 2010
e. 2011
2. According to information from the Federal Reserve Board, delinquencies at commercial banks
on “all loans and leases” have fallen to levels last seen in ________:
a. 2007
b. 2008
c. 2009
d. 2010
e. 2011
3. As of mid October of 2011, the largest bank by assets in the United States was:
a. JP Morgan Chase
b. Bank of America
c. Wells Fargo
d. Citibank
e. Goldman Sachs
4. As of the end of 2010, the largest bank by assets in the United States was:
a. JP Morgan Chase
b. Bank of America
c. Citibank
d. Goldman Sachs
e. Wells Fargo
5. As of mid October of 2011, the second largest bank by assets in the United States was:
a. JP Morgan Chase
b. Bank of America
c. Wells Fargo
d. Citibank
e. Goldman Sachs
6. Which of the following is not one of the essential issues in evaluating commercial loan
requests?
a.
The structure of the borrower’s board of directors.
a.
The character of the borrower.
b.
The use of the loan proceeds.
c.
The source of repayment for the loan.
d.
The amount the customer needs to borrow.
7. All of the following are basic sources of cash flows except:
a.
liquidating assets.
b.
cash flows from operations.
c.
issuing new equity.
d.
liquidating liabilities.
e.
issuing new debt.
8. Which of the following characteristics should collateral have?
a.
The value of the collateral should not exceed the value of the loan.
b.
The collateral should be highly liquid.
c.
The lender must be able to perfect a lien on the collateral.
d.
a. and b. only.
e.
b. and c. only.
9. Which of the following is not part of the four-stage process for evaluating the financial aspects
of commercial loans?
a.
An analysis of the firm’s management, operations, and industry.
b.
Performing financial ratio analysis.
c.
Analyze the firm’s cash flow.
d.
Examining the backgrounds of the sales force.
e.
Project the borrower’s financial condition.
10. Which of the following is a correct interpretation of a total asset turnover of .33 (one-third)?
a. For each $1 of sales generated by the firm it requires $3 in assets.
b. For each $1 of assets owned by the firm it generates $3 in sales.
c. For each $3 of sales, the firm makes $1 in net profit after taxes.
d. The firm completely replenishes its available assets 3 times per year.
e. The firm completely replenishes its available assets every 3.0 days.
11. Your company had net sales of $70,000 over the past year. During that time, average
receivables were $10,000. What was the average collection period?
a.
7 days
b.
12 days
c.
30 days
d.
43 days
e.
52 days
12. Which of the following items is included as part of a company's current assets?
Accounts payable.
a.
Inventory.
b.
Accounts receivable.
c.
d. Statements b and c are correct.
All of the statements above are correct.
e.
13. All else being equal, which of the following will increase a company's current ratio?
An increase in accounts receivable.
a.
An
increase in accounts payable.
b.
c. An increase in net fixed assets.
d. Statements a and b are correct.
e. All of the statements above are correct.
14.
14. Which of the following alternatives could potentially result in a net increase in a company's
cash flow for the current year?
15.
a. a Reduce the days sales outstanding ratio.
b. . Increase the number of years over which fixed assets are depreciated
c. Decrease the accounts payable balance.
d. a Statements a and b are correct.
e. . All of the statements above are correct.
15.
How efficiently a firm is using its assets is measured by:
a.
liquidity ratios.
b.
market value ratios.
c.
profitability ratios.
d.
activity ratios.
e.
leverage ratios.
16.A firm’s mix of debt and equity is measured by:
a. liquidity ratios.
b. market value ratios.
c. profitability ratios.
d. activity ratios.
e. leverage ratios.
17. A firm’s ability to meet its short-term debt obligations is measured by:
a. liquidity ratios.
b. market value ratios.
c. profitability ratios.
d. activity ratios.
e. leverage ratios.
18. Which financial ratio measures a firm’s ability to pay current interest and lease payments with current
earnings?
a. Fixed charge coverage ratio
b. Return on equity
c. Current ratio
d. Inventory turnover
e. Debt to total assets ratio
19. A firm has the following financial statement data: Sales = $1,000, COGS = $400, Operating Expenses = $200,
and Taxes = $200. What is the firm’s profit margin?
a. 10%
b. 20%
c. 30%
d. 40%
e. 60%
20. A firm has the following financial statement data: Sales = $2,000, COGS = $800, Operating Expenses = $600,
and Taxes = $400. What is the firm’s profit margin?
a. 10%
b. 20%
c. 30%
d. 40%
e. 60%
21. Cash flows from a firm’s normal business activities are reflected in:
a. cash flows from investing.
b. cash flows from financing.
c. cash flows from operations.
d. cash flows from income.
e. cash flows from budgeting.
22. All of the following are sources of cash except:
a. an increase in long-term debt.
b. a decrease in inventory.
c. a new equity issue.
d. a decrease in notes payable.
e. an increase in accounts payable.
23. Which of the following is not a use of cash?
a. A decrease in accounts payable
b. An increase in inventory
c. An increase in accounts receivable
d. The payment of cash dividends
e. An increase in wages payable
Use the fFollowing information on Dylan Enterprises for questions 24- 29
Income Statement
Revenues
Less: Cost of Goods Sold
Gross Profit
Less: Operating Expenses
Less: Depreciation
Operating Profit
Less: Interest Expense
Net Profit Before Taxes
Less: Taxes
Net Income
$320,000,000
$162,000,000
$158,000,000
$120,000,000
$11,000,000
$27,000,000
$8,500,000
$18,500,000
$6,290,000
$12,210,000
Earnings Available to Common
Dividends Paid (60% of EAC)
Addition to Retained Earnings
$12,210,000
$7,326,000
$4,884,000
Earnings Per Share
Assets
Cash
Marketable Securities
Accounts Receivable
Inventory
Pre-Paid Expenses
Total Current Assets
Long-Term Assets
Total Assets
Liabilities
Accounts Payable
Short-Term Debt
Total Current Liabilities
Long-Term Debt (8%)
Total Liabilities
Common Stock ($1 Par)
Paid-In Capital
Retained Earnings
Total Equity
Total Liabilities and Equity
$6.11
Balance Sheet
Current Year
$1,500,000
$1,500,000
$57,000,000
$106,000,000
$8,400,000
$174,400,000
$148,000,000
$322,400,000
Prior Year
$3,000,000
$3,200,000
$44,000,000
$99,000,000
$11,000,000
$160,200,000
$154,000,000
$314,200,000
Change
($1,500,000)
($1,700,000)
$13,000,000
$7,000,000
($2,600,000)
$14,200,000
($6,000,000)
$8,200,000
Current Year
Prior Year
Change
$8,716,000
$102,000,000
$110,716,000
$115,000,000
$225,716,000
$2,000,000
$65,000,000
$29,684,000
$96,684,000
$322,400,000
$6,400,000
$105,000,000
$111,400,000
$111,000,000
$222,400,000
$2,000,000
$65,000,000
$24,800,000
$91,800,000
$314,200,000
24. What were Dylan's cash receipts during the year?
a. $307,000,000
b. $320,000,000
c. $323,000,000
d. $424,000,000
e. $482,000,000
Cash Receipts From Sales = Net Sales – Change in Accounts Receivable
Cash Receipts From Sales = $320,000,000 - $13,000,000 = $307,000,000
$2,316,000
($3,000,000)
($684,000)
$4,000,000
$3,316,000
$0
$0
$4,884,000
$4,884,000
$8,200,000
25. What is Dylan's cash flow from operations?
a. -$2,874,000
b. $8,126,000
c. $12,210,000
d. $19,126,000
e. $23,210,000
Cash Flows from Operating Activities
Net Income
Adjustments to Net Income
Deprecation
Change in Accounts Receivables
Change in Inventory
Change in Pre-Paid Expenses
Change in Accounts Payable
Total
Net Cash Provided (Used) by Operating Activities
$12,210,000
$11,000,000
($13,000,000)
($7,000,000)
$2,600,000
$2,316,000
($4,084,000)
$8,126,000
26. What is Dylan's current ratio for the current year?
a. 1.36
b. 1.44
c. 1.58
d. 1.68
e. 1.71
Current Ratio = Current Assets/Current Liabilities = $174,400,000/$110,716,000 = 1.575
27. What is Dylan's return on assets for the current year?
a. 3.8%
b. 5.1%
c. 5.4%
d. 12.6%
e. 13.3%
ROA = Net Income/Total Assets = $12,210,000/$322,400,000 = .0378
28. What is Dylan's equity multiplier for the current year?
a. 0.30
b. 0.63
c. 1.52
d. 2.67
e. 3.33
Equity Multiplier = Total Assets/Common Equity = $322,400,000/$96,684.000 = 3.33
29. What is Dylan's return on equity for the current year?
a. 3.8%
b. 5.1%
c. 5.4%
d. 12.6%
e. 13.3%
Return on Equity = Net Income/Common Equity = $12,210,000/$96,684,000 = .1263
Or
Return on Equity = ROA * Equity Multiplier = .0378 * 3.33 = .1258
30. At a minimum, cash flow from operations should cover:
a. interest on long-term debt.
b. dividends plus mandatory principal payments on debt.
c. capital expenditures plus dividends.
d. the change in marketable securities.
e. dividends plus interest.
31.Under which category are dividends classified on the statement of cash flows?
a. Cash From Investing Activities
b. Cash From Operating Activities
c. Cash From Financing Activities
d. Cash From Profit Activities
e. None of the above
32. Which of the following would cause a firm's ROE to be high, but its ROA to be low?
a. A low gross profit margin but a high net profit margin.
b. Financing a relatively large proportion of assets with equity.
c. Paying very low interest rates on the firm's debts.
d. Leasing a large amount of equipment.
e. Financing a relatively large proportion of assets with debt.
16.
17. c
.
18. d
.
19. e
.