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CHAPTER 20 - Answer
CHAPTER 20 - Answer
CHAPTER 20
SHORT-TERM SOURCES
FOR FINANCING CURRENT ASSETS
I. Questions
2. The prime rate is the rate that a bank charges its most creditworthy
customers. The average customer can expect to pay one or two percent
(or more) above prime.
3. The stated interest rate is the percentage rate unadjusted for time or
method of repayment. The effective interest rate is the true rate and
considers all these variables. A 5 percent stated rate for 90 days provides
a 20 percent effective rate. The financial manager should recognize the
effective rate as the true cost of borrowing. The effective rate is also
referred to as the APR (Annual Percentage Rate).
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Chapter 20 Short-term Sources for Financing Current Assets
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Short-term Sources for Financing Current Assets Chapter 20
III. Problems
Problem 1
RATE = 46%
Problem 2
Note that Jan would actually have to borrow more than the needed
P500,000 in order to cover the compensating balance requirement.
However, as we demonstrated earlier, the effective cost of credit will not
be affected by adjusting the loan amount for interest expense changes
accordingly.
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Chapter 20 Short-term Sources for Financing Current Assets
However, for the August trade credit the firm actually pays at the end of
the credit period (the 30th day), so that the cost of trade credit becomes
= P10,000
= .18, or 18%
.16 x P200,000 1
b. RATE = P200,000 .20 x P200,000 x 1
= .21212, or 21.212%
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Short-term Sources for Financing Current Assets Chapter 20
Problem 4
Cost of not taking Discount % 360
a cash discount =
100% Disc.% x due date-
Final
2% 360 Discount period
98% (55 10)
= x = 2.04% x 8 = 16.32%
= Interest rate / (1 C)
= 14% / (1 .2)
= 14% / (.8) = 17.5%
The effective cost of the loan, 17.5%, is more than the cost of passing up the
discount, 16.32%. Kiwi Corporation should continue to pay in 55 days and
pass up the discount.
Problem 5
P5,500 360
a. Effective rate of interest = P300,000 x 60
= 1.83% x 6 = 10.98%
2% 360
b. Cost of lost discount = x
98% (70 10)
= 2.04% x 6 = 12.24%
c. Yes, because the cost of borrowing is less than the cost of losing the
discount.
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Chapter 20 Short-term Sources for Financing Current Assets
P6,850 360
P375,000 P75,000 60
= P375,000 amount
P6,850needed to be borrowed
e. Effective interest rate = P300,000 x
= x 6 = 2.28% x 6
= 13.68%
Problem 6
Northeast Bank
2 x 12 x P9,000
(P100,000
Effective interest rate P10,000) x (12 + 1)
Choose Northeast Bank since it has the lowest effective interest rate.
b. The numerators stay the same as in part (a) but the denominator increases
to reflect the use of more money because compensating balances are
already maintained at both banks.
Trust Bank
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Short-term Sources for Financing Current Assets Chapter 20
Northeast Bank
Problem 7
a. 11.73%
b. 12.09%
c. 18%
Costs incurred by using commercial paper
Problem 8 Net funds available from commercial paper
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Chapter 20 Short-term Sources for Financing Current Assets
= 2.345%
= 2.20%
Effective cost = 1st quarter cost + 3(cost of 2nd, 3rd, 4th qtrs.)
= .02345 + 3(.02200)
= .02345 + .06600
= .08945
= 8.95%
Familia Inc. should choose commercial paper because the cost of bank
financing (10.4 percent) exceeds the cost of commercial paper (8.95
percent) by greater than 1 percent.
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Short-term Sources for Financing Current Assets Chapter 20
Problem 9
a. The expected monthly cost of bank financing is the sum of the interest
cost, processing cost, bad debt expense, and credit department cost. The
calculations are as follows:
b. The expected monthly cost of factoring is the sum of the interest cost and
the factor cost. The calculations are as follows:
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Chapter 20 Short-term Sources for Financing Current Assets
Problem 10
The cost of each supplier must be weighted by the proportion of the total
provided by the supplier.
Annual Weighted
Percentage Cost Weight Average Cost
Supplier (1) (2) (1) x (2)
Fort Co. .367 .30 .110
Jester Co. .242 .25 .061
Jam Co. - .35 -
Smitt & Co. .172 .10 .017
Total 1.00 .188
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Short-term Sources for Financing Current Assets Chapter 20
b. No, the average effective annual interest rate does not indicate whether
they should borrow funds to take advantage of the terms on a specific
account. The borrowing decision should be based on the effective annual
interest rate of each suppliers credit terms. Money should be borrowed
to pay within the discount period only when the cost of borrowing is less
than the effective annual interest rate of the credit terms. For instance,
Fort Co. has an effective annual interest rate of 36.7% and should be paid
on day 10 only if the cost of borrowing is less than 36.7%.
c. 1. A line of credit is a loan agreement in which the borrower has, with
certain specified limitations, control over the amount borrowed (up
to some maximum) and when the funds are repaid.
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