Instruction 8.1: For the Following Problem(s), Consider These Debt Strategies Being Considered

question 17

Multiple Choice

Instruction 8.1:
For the following problem(s) , consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #2 will:

• A) guarantee the lowest average annual rate over the next three years.
• B) eliminate credit risk but retain repricing risk.
• C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
• D) preclude the possibility of sharing in lower interest rates over the three-year period.

---

Definitions:

Machine-hours

A measure of production output based on the number of hours machines are operated within a given period.

Variable Overhead Rate Variance

The difference between the actual variable overhead incurred and the standard variable overhead assigned to the production based on the actual activity levels.

Total Variable Overhead Spending Variance

The overall difference between actual and budgeted variable overhead costs based on the changes in the level of activity.

Variable Overhead

Costs that fluctuate with the level of production output, including indirect expenses like power and materials needed for maintenance and operations.