Young Company has a 7 percent annual interest rate on its bank loan which the company is in the process of repaying. The loan currently has a principal balance of $15 million. Young Company provides financial statements to the bank in order to meet the bank's loan requirements. Young prepares its financial statements with some help from a local CPA, who provides advice in preparing journal entries and closing the books. Young Company approached several other banks and found two that were willing to offer loans at competitive rates. Country Valley Bank offers a 6 percent annual interestrate for small businesses that involve a CPA in helping prepare their financial statements. Communitv Bank offers a 4.5 percent rate on its loan but would require that Young Company have its financial statements separately audited by an independent CPA firm each year to get that lower rate. Young Company reached out to a local CPA firm and received an estimate of $145,000 annually to provide an independent audit opinion on Young's financial statements each year. Using your understanding of the steps in the audit process described in Chapter 1, describe why Community Bank is willing to offer a lower interest rate to Young Company if it receives an audit of its financial statements. Calculate the annual costs of the loan for Young Company under each loan scenario. Be sure to include the costs of interest and of hiring the CPA or CPA firm. Use these analvses to justify y

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter16: Working Capital Policy And Short-term Financing

Section: Chapter Questions

Problem 31P

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Young Company has a 7 percent annual interest rate on its bank loan which the company is in the process of repaying. The loan currently has a principal balance of $15 million. Young Company provides financial statements to the bank in order to meet the bank's loan requirements. Young prepares its financial statements with some help from a local CPA, who provides advice in preparing journal entries and closing the books. Young Company approached several other banks and found two that were willing to offer loans at competitive rates. Country Valley Bank offers a 6 percent annual interestrate for small businesses that involve a CPA in helping prepare their financial statements. Communitv Bank offers a 4.5 percent rate on its loan but would require that Young Company have its financial statements separately audited by an independent CPA firm each year to get that lower rate. Young Company reached out to a local CPA firm and received an estimate of $145,000 annually to provide an independent audit opinion on Young's financial statements each year.

Using your understanding of the steps in the audit process described in Chapter 1, describe why Community Bank is willing to offer a lower interest rate to Young Company if it receives an audit of its financial statements.

Calculate the annual costs of the loan for Young Company under each loan scenario. Be sure to include the costs of interest and of hiring the CPA or CPA firm. Use these analvses to justify your recommendation as to whether Young Company should keep its current loan or accept one of the new loan offers.

Assume Young Company accepts the loan offer from Community Bank and hires a CPA firm to perform a financial statement audit. As part of auditing Young's financial statements, an audit requires that the auditor obtain an understanding of the entity's internal control over financial reporting. Why might Community Bank be interested in the work conducted by auditors in this phase of the audit?

Now assume Young Company does not have an option to refinance its loan, given its agreement with its current bank. Is there any reason Young Company might still choose to have its financial statements audited by a CPA firm?

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