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97 views16 pagesShort Term Financing Important Questions For Exam
The document provides a comprehensive list of financial formulae related to discount rates, effective annual interest rates, loan calculations, and payroll expenses. It includes examples of calculating average accruals, annual percentage costs, and effective interest rates for various financing alternatives. Additionally, it discusses the cost implications of different financing options for companies, emphasizing the importance of selecting the most cost-effective solution.
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0% found this document useful (0 votes)
97 views16 pagesShort Term Financing Important Questions For Exam
The document provides a comprehensive list of financial formulae related to discount rates, effective annual interest rates, loan calculations, and payroll expenses. It includes examples of calculating average accruals, annual percentage costs, and effective interest rates for various financing alternatives. Additionally, it discusses the cost implications of different financing options for companies, emphasizing the importance of selecting the most cost-effective solution.
Uploaded by
Nirajan SilwalCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
/ 16
g List of Formulae
Discount rate
- Daysi
100 - Discount rate * ne ee
Credit period - Discount perid fey
Effective annual interest rate _ [: «Discount percent _7 ™”""""™
5 of nottaking discount 100 = Discount rereni] -1 (4.2)
7 psective annual interest rate = AanuaLinterest aay
|g Biketive annual interest rate = [: “Reruaicaeee] a4)
B Effective annual interest rate = y-——tnterest —_—_ (as)
B Effective annual interest rate = [1 + Annual interest/m —__]" _ (4.6)
Loan amount - Annual interest/m
- Interest
Loan amount - C.B)- Interest (discounted)
1+ Interest /m_
JS Bdective interest rate ~ [) * Loan GB Interest DacoameaTa] “1
Interest césts + Commitment fee 365
© Annual percentage cost - Net amount used * Number of days fund used
1B Effective annual interest rate 4.7)
(4.8)
(4.9)
Interest costs + Placement cost 365.
|G Annual percentage cost 5 ‘Net amount used * Maturity (days)
Interest + Fees, 365
Annual percentage cost “Net amount used “ Number of days fund used
(4.10)
(4.1)
Kecekly pdyrott of Rs 600,000. The firm is considering changing
twice a month payroll to reduce the cost of writing checks and similar expenses which
eas | 000 per payroll. The firm has a 10 percent opportunity cost.
Required: 4 )
a ‘What is average accrual under present payroll system?
on isa total annual payroll expense under present payroll system? © What will be average accruals under proposed plan?
d. What will be total annual p,
e. What will be total annua
weekly?
ayroll expenses under proposed plan?
I savings if wages were paid twice a month instead of
Solution
Average accruals under present payroll system
_ . Amount of payroll per pay day _ Rs 600,000 500,000
Total annual payroll expenses under present payroll’system
_ = Payroll expenses per pay day x Number of pay day in a year
= Rs 1,000 x 52
= Rs 52,000
© Average accruals if company pays wages twice a month
- —- Amount of bovrell per pay day.» Rs 100,000 Rs 650,000
Here amount of payroll per payday
= Amount of payroll under préseht system x No. of pay days in a year under present system
= Number of pay days in a year under proposed system
__ Rs 600,000 x 52
~ 24
= Rs 1,300,000
2 Aisi amount of annual payroll expenses under proposed plan
iY
= Rs 000% 24 = Rs 24,000
x _@alculation of annual savings
a fease in average accruals from change in payroll expenses
= Rs 650,000 — 300,000 = Rs 350,000
Interest savings from increase in average accruals = Rs 350,000 x 10%
‘Add: Annual payroll expenses savings (52,000 — 24,000)_
Total annual savings
e ae jers buys under terms of 2/15, net 60. Compute arma geetage cost under
of the following conditions assuming 365 days in a year.
if company does not take discount and pays on 40" day?
‘c._écompany stretches the credit period by 10 days.
If company actually pays on 25 day and stilbtake the discount, what is the cost of
we free trade credit? oC
ON trate = 2% &
Discount period = 15 days...
s”
c»
bis does not take discount and pays on due dai. @ Credit period = 60 days
Days inayear = 365 days
We have,
Discount rate. Days ina
Annual percentage cost = 799 Discount rate * Credit period i
iscount periay
a. _ If company does not take discount and payron de date
Annual percentage cost (APC) = wa" 3 a - s = 0.1655 oF 16.55%
b, — Ifcompany does not take the discount and pays on 40th day
Annual percentage cost (APC) “ma 3 ps 15 7 0.2980 or 29.80%
~ Afcompany stretches the redit period by 10 day
Annual percentage cost (APC) “mo 3" ws [5 70-1354 oF 13.54%
d. If company actually pays on 25th day and still takes the discount
Annual percentage cost (APC) of non-free trade credit
2
avs = 0.2128 or 21.28%
~ 100-2" 60-25 ft
rya Company wishes to borrow Rs 500,000 fo: of year. It has the followiy
Iterwatives available to it.
Aa A15 percent loan ona collect basis with no compen balance req
b. A 12 percent loan on a discount basis with 10 percent compensating balarea
required, ee
& A 10 percent loan on a discount basis wvith45 5 percent compensating balane
“required.
Which alternative should the Surya Conny toss cence with the effective
interest rate?
a
Given,
‘Amount to be raised = Rs 500,000
a. Interest rate = 15% on collect basis
Interest
Hiecive ners se (EIR) = Toaxamount CB.” Re S00 900-0 = 015018
_7 b Interest rate =12% on a discount basis
Interest x
Compensating balance (C.B.) = 10%
foterest rate (EIR) = Tar amount CHSISeraaT
Ee
Rs 500,000 - + Rs 50,00) = Rs 60,000
“01
Interest rate * 10% on Pipe er saa
Compensating balance (C.B,) = 15%
‘cert IR) “Caran Es
“ = 011339 or 13:33
PME: =— \daki Noodles Company intends to borrow Rs 450,000 to support its short-term
fancing requirements during the next year. The company is evaluating its financing
options at the bank where it maintains its checking account. Gandaki's checking accoure
on the average holds the balance of Rs 50,000. It can be used to satisfy any compensating
balance requirements the bank might impose. The financing alternatives offered by the
bank include:
Kiternative
discount interest loan with a simple interest of 14 percent and no
compensating balance requirement.
A 12 percent simple interest loan that has a 15
balance requirement.
Alternative 3: Rs 1 million revolving line of credit with simple interest of 12 percent
a paid on the amount borrowed and a 1 percent commitment fee.
_ae-Gompite the effective cost (fae) of each financing alternative assuming Gandaki
borrows Rs 450,000, Which alternative should it use?
7 Sei how much would Gandaki have to borrow in order to have
,000 available for use (to pay the firm's bills)?
a iven,
Netamiount required = Rs 450,000
‘und available for requirement of compensating balance 4Rs50,000
ternative 1
h t rate = 14% on discount basis
Alternative Percent compensating
core 4 Interest
‘tive interest rate (EIR) Net usable amount
fe Interest
oe : =[oan=CB.- Interest (discounted)
2 re am ee = 0.1628 or 16.28%
Alternative 2
Interest rate = 12%
‘Compensating balance =15%
54,000
EIR = 450,000 [67,500 -50,000]
54,000
450,000 - 17,500
Alternative 3
Sunt of line of credit = Rs. 1 million
terest rate =12%
Coy =1%
ymitment fee
rest = 450,000 « 12% = 54,000
Commitment fee = 550,000 x 1% = 5500
Total cost = 59,500
erp 59.500
EIR = $55,990 ~ 0.1322 or 13.22%
= 0.1249 or 12.49%
Gandaki Noodles Company should use alternative 2. Amount to be borrowed to get net Rs 450,000
Alternative 1
Let amount to be borrowed is X
Then, X - Discount interest = Rs 450,000
or, X - 0-0.14X = Rs 450,000
or, 0.86X = Rs 450,000
xa Red
Alternative 2
Amount to be borrowed?
X-=C.B. - Interest (discounted) = Rs 450,000
or, X= (0.15x - 50,000) = Rs 450,000
or, 0.85X = 450,000 - 50,000
or, 0.85X = Rs 400,000
__ Rs.400,000 _
X= O85. Rs 470,588.23
000 _ Rs, 5232558
Alternative 3
Amount to be borrowed = Rs 450,000
so Air borrowed Rs 100,000 from Himalayan Bank, Thé loan was made at a
crn
\ug) interest rate of 12 percent a year for three months. A 20 percent comper
fice requirement raised the effective interest rate,
a. Whatis the true effective rate?
simp
Nsating
b, What would be the effective cost of the loantif the note required discount interest?
© What would be the effective annualinterest rate on the loan if Himalayan Bui
required Buddha Air to repays.the loan and interest in three equal month
installments? No compensating balance is required in this
alternative.
on
Given,
Amount of loan =Rs 100,000
Interest rate = 12% .
Compensating balance (CB) = 20%
oe Effective interest rate
Interest/m “
BIR -[ *Toan-CB-Interest/m (aroma =t
[is 1000/4
700,000 - 20,0070 | - 1 = 0.1587 or 15.87%
a is discounted, effective interest rate
"
EIR -[1 * Too O TERT] ~ 10,1652 or 16.52%
Amount of loan + Interest 100,000 +3,
Ken Payment =" Number of payments y= 38
We have,
PVa= PMT « PVIFA,
or, 100,000 = 34,333 x PVIFA, 5
or, PVIFA,3=2.9126
a
Referring to PVIFA Table in 3 periods row, we find 2.9126 lies between 2.94108"
2.8839 which are corresponding to 1% and 2% respectively. eno
ae
Sete a Factorun = Factors
BR oS CHR -LR)
torin = Factori &
2.9410 - 2.9126
Lo. 71% * Zon10-2.8839 * 1% ° 1.5%
4 ‘nnual interest rate = 1.5% « 12 = 18%
Effective interest rate= (1 + 0.015). 1 = 19.56%
‘The Phoenix Company needs to increase its working capital by Rs 10 million. It has
Ze that there are essentially three alternatives of financing available:
‘a. Forgo cash discounts, granted on a basis of 3/10, net 30.
b, Borrow from the bank at 15 percent. This alternative would necessitate maintaining a
7 Tapercent compensating balance.
€. Issue commercial paper at 12 percent. The cost of placing the issue would be
Rs 100,000 each 6 months.
Assuming that the firm would prefer the flexibility of bank financing, provided the
additional cost of this flexibility is no more than 2 percent, which alternative should
Phoenix select?
Given,
Additional fund needed = Rs 10 million \ Q yw ©
Annualized costs are as follows:
T
Cnn credit —————
7 _ Discount rate 365 days red
oO APC "100 — Discount rate * Credit period — Discount period \g \ |
(3B 365 days
=97* 20 days = 0.5644 of 56.44% <
Jo, 6 VO
b. financing
Interest
= Face amount= Compensating balance eH omy - ROE
ae Rs 10,000,000 0.15, AWE,
- 2,000, O00 x0"? = Au
TR='8800,000° 01705 =17.05%
« ercial paper ee INWY
ee
Apc =—_hotalcost— _ Rs 1400.00 o1d= 14%
="Kmount used ~ Rs 10,000,000
RS 10,000,000 x 0.12
i cost = Rs 100,000 x 2
‘The bank financing is approximately 3 percent more expensive than the commercial
paper. Therefore, commercial paper should be issued.
® The Fox Company is able to sell Rs 1 million of commercial paper every three months at
arate of 10 percent and a placement cost of Rs 3,000 per issue. The dealers require Fox to
maintain bank lines of credit demanding Rs 100,000 in bank balances, which otherwise
would not be held. Fox has a 40 percent tax rate, What does the fund from commercial
paper cost Fox after taxes? on
Given,
Face amount of commercial paper = Rs 1 million
Interest rate per annum = 10 percent
Placement cost per issue = Rs 3,000
Bank line of credit demanding = Rs 100,000
Corporate tax rate (T) = 40%
After tax cost of commercial paper =?
Total annual interest (Rs 1,000,000 x 0.10) = Rs 100,000
Placement cost (Rs 3,000 x 4) = Rs 12,000
Total cost =Rs.112,000
Net amount used (Rs 1,000,000 - Rs 100,000) = Rs 900,000
Total cost___ Rs.112,000
Commercial paper cost (before tax) =iotamount used ~ Rs.900,000 ~ 1244 = 1243,
Commercial paper cost (after tax) = Before tax cost (1 -T) = 12.44% (1-04) = 7.46%
110, Himalayan Herbal Company estimates that due to the seasonal nature of its business,
oo” will require an additional Rs 200,000 of cash for the month of July. Himalayan Her
Company has four options available to provide the needed funds. It can
1. Establish a one-year line of credit for Rs 200,000.with a commercial bank. Thy
commitment fee will be 0.5 percent, and the interest charge on the used funds will'e
15 percent per annum. The minimum time the funds can be used is 30 days.
2 Forego the July trade discount of 2/10, net 40-on Rs 200,000 of accounts payable.
3. Issue Rs 200,000 of 60 day commercial paper at a 14 percent per annium interest re,
Since the funds are required for only 30)days, the excess funds (Rs 200,000) can b
__ invested in 13 percent per annum marketable securities for the month of August. The
total transaction fee on purchasing and selling the marketable securities is 0.5 perced
of the fair value.
a. Which financial arrangement results in the lowest cost?
b. Is the source with the J6west expected cost necessarily the source to select? Why
why not?
a. Given, y
Additional funds needed — = Rs 200,000
Option 1: Line of credit .
Line of credit amount = Rs 200,000
Commitment fee = 0.5 percent on unused amount
Interest charge = 15 percent on used amount
Time period =30 days
mputation of cost of line of credit
Comment ice (Rs 200,00 x 010s «880530
30
Interest charge (rs 200,000 x 0.15 x 360,
Total cost
Option 2: Trade discount
Credit terms = 2/10, net 40
‘Accounts payable = Rs 200,000 Cost of trade discount = Accounts payable x Discount rate
= Rs 200,000 x 0.02 = Rs 4,000
Option 3: 60-day commercial paper
Face value = Rs 200,000
Maturity period
Interest rate
Return from marketable securities = 13 percent
Transaction fee =05 percent of fair value
Computation of Total Cost of Commercial Paper
Interest charge (Rs 200,000 x 0.14 x )
Transaction fee (Rs 200,000 x 0.005)
Total cost Rs 5,666.87
Less: Return from marketable securities (re 200,000 x 0.13 B) Rs 2,166.67
Net cost
The first option line of credit has lowest cost among three options.
b. Generally, the-financial manager may choose least cost sources ‘of financing.
However, the factors other than cost such as impact on credit rating, reliability,
restrictions, flexibility may be important. So, one should also consider these
qualitative factors while selecting right sources of financing. Annual percentage cost
__Interest + Fees 365 4.11
“Net amount used “ Number of days fund used (4.11)
To illustrate, Anil Manufacturing Company is considering obtaining funding
through advances against receivables. Terms are net 30 days, average receivables
are Rs 800,000 and payment is made on the average in 30 days. Sunrise Bank will
advance funds under a pledging arrangement for 15 percent annual interest and
payable at the end of period and requiring 20 percent(feserve. What is the
annual percentage cost? What is the effective cost?
First, calculate the net amount received and tofal annual cost then annual
percentage cost
Step 1: Calculate the net amount received or net proceeds
Average receivable outstanding Rs 800,000
Less: Reserve (0.20 x Rs 800,000) 460,000
Net amount received Rs 640,000
Step 2: Calculate the total annual cost
Interest cost (Rs 640,000 x 0.15) Rs 96,000
Total annual rupee cost Rs 96,000
Step 3: Calculate the annual percentage cost
Ann Total cost _ __Rs 96,000
tual percentage cost = Net proceeds ~ Rs 640,000
tage cost\™
Effective cost ~ (1+ Anau percentag 4
= 0.15 or 15%
0.1512
=(1+>) -1=0.16075 or 16.08%
* Borrower is responsible to bear bad debt loss under pledging accounts
receivable. |
To illustrate, Mechi Company is considering to raise funds through factoring
arrangement. The average receivables outstanding are Rs 800,000 and terms are
net 30 days. People Finance offers factoring on a non-recourse basis for a 25
percent factoring commission charging 1 percent per month on advances and
requiring a 20 percent factor's reserve. Under this plan, the firm would factor al]
accounts and close its credit and collection department, saving Rs 200,000 per
year. What is the annual percentage cost? What is effectivexcost? |
First, calculate the net amount received and total (annual cost then annual
Percentage cost
Step 1: Calculate the net amount received or net proceeds
Average receivable outstanding Rs 800,000
Less: Reserve (0.20 x Rs 800,000)
Less: Factoring commission (0.025 x Rs 800,000)
Less interest charge (0.01 x Rs 620,000),
Net amount received
Step 2: Calculate the total annual cost
Interest cost (Rs 6,200 x 12).
Commission (Rs 20,000. 12)
Total cost
Less: Credit department savings
Total annual rupee cost oO
Step 3: Calculate the annual percentage cost C)
Total cost Ro 114,400
“Net Proceaga Rs 613,800
Effective cost ~(1 «Armas nee ony
( ans)
matey = 1= 0.20318 or 20.318%
oS
Annual percentage cost
= 0.1864 oF 1hOA% To illustrate suppose, Himalaya Herbal Company faces a liquidity crisis. It needs
a loan of Rs 100,000 for 30 days. Having no source of additional unsecured
borrowing, the firm must find a secured short-term lender. The firm's accounts
receivable are quite low, but its inventory is considered liquid and reasonably
good collateral. The book value of inventory is Rs 300,000, of which Rs 120,000 is
finished goods. The company has the following three alternatives.
Alternative 1: Center City Bank will make a Rs 100,000 trust receipt loan against
the finished goods inventory. The annual interest rate on the loan is 12 percent
on the outstanding loan balance plus a 0.25 percent administration fee levied
against the Rs 100,000 initial loan amount. Because it will be liquidated as
inventory is sold, the average amount owed over the month is expected to be
Rs 75,000.
Alternative 2: First Local Bank is willing to lend Rs 100,000 against a floating
lien on the book value of inventory for 30-day period at ariannual interest rate of
13 percent.
Alternative 3: North Mall Bank and Trust will loan Rs 100,000 against the
finished goods inventory and charge 15 percent annual interest on the
outstanding loan balance. A 0.5 percent watehousing fee will be levied against
the average amount borrowed. Because the loan will be liquidated as inventory
is sold, the average loan balance is expected to be Rs 60,000. Calculate the cost of
each of the proposed plans for obtaining an initial loan amount of Rs 100,000.
Which plan should the company use?
At first, the company should-compute cost of each alternative.
Cost of Alternative 1- Trust receipt loan
Interest cost (Rs 75,000°)0.12 x 1/12)
‘Administrative fee (Rs 100,000 x 0.0025)
Total cost
Cost of Alternative 2- Floating lien
Interest cost (Rs 100,000 x 0.13 x 1/12)
Total cost
Cost of Alternative 3- Warehouse financing
Interest cost (Rs 60,000 x 0.15 x 1/12) Rs 750
‘Administrative fee (Re 60,000 x 0.005) 300
Total cost Rs 1,050
Rs 1,083.33
Rs 4,
ae
Se SF on
vadded
and
estis
tl §, ¥
Rs 10,000 plus interest RS 1200.
