Sample Problems for Short-Term Financing Agreement

Problem 1.Swissship Company, a large ship builder, has issued P10 million worth of commercial paper that has a 90-day maturity and sells for P9.85 million.
The securities are to be redeemed at par value on its maturity date. Calculate the effective cost of issuing the commercial paper.

Problem 2. Capote Company, a manufacturer of children’s rainwear, is studying to factor its P2 million worth of accounts receivable. The factor will hold a
15% reserve, charge on and deduct from the book value of the factored accounts a 2% factoring commission, and charge a 1% per month interest on
advances. The company expects to generate savings from collection in the amount of P20,000. Determine the annualized effective financing cost, assuming
the factoring activity, is a single transaction and further assuming:
a. The interest is not deducted in advance.
b. The interest is deducted in advance.

Problem 3. Precious Toy Company, a manufacturer of inexpensive children’s toys, needs a loan of P300,000 for 60 days. The company primary bank has
told management that a loan secured under a floating inventory lien is possible. The annual interest rate is 14%, which is 5% above the prime rate. Funds
would be advanced up to 60% of the average book value of the secured inventory.
Required:
a. The average book value of inventory to be used as lien.
b. The periodic effective cost of inventory financing.
c. The annualized effective cost of inventory financing.

Problem 4. The Lupa Company, a real estate developer, has a P2 million revolving credit agreement with a bank. Its average borrowing under the
agreement for the past year was P1.5 million. The bank charges a commission fee of 1%. The nominal rate on used fund is 12%. Determine the effective
cost of revolving credit agreement.

Problem 5.The Frame Supply Company has just acquired a large account and needs to increase its working capital by P100,000. The controller of the
company has identified the four sources of funds given below:
1. Pay a factor to buy the company’s receivables, which average P125,000 per month and have an average collection per period of 30 days. The
factor will advance up to 80% of the face value of receivables at 10% interest and charge a fee of 2% on all receivables purchased. The controller
estimates that the firm would save P24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance.
2. Borrow P110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3. Issue P110,000 of 6-month commercial paper for P100,000. (New paper would be issued every 6 months.)
4. Borrow P125,000 from a bank on a discount basis at 20%. No compensating balance would be required.
Assume a 360-day year in all your calculations.
Required: Compute the cost of each alternative and identify which financing will Frame Supply Company should use.

Problem 6. A company received a line of credit from its bank. The stated interest rate is 12%, deducted in advance. The line of credit agreement requires
that an amount equal to 20% of the loan be deposited into a compensating balance account. On March 1, the company drew down the entire usable amount
of the loan and received proceeds of P340,000. How much is the principal of the loan?

Problem 7. What is the current price of a P100,000 treasury bill due in 180 days on an 8% discount basis?

Problem 8.The company purchase a machine through a P100,000 loan on an add-on basis at a nominal rate of 12% payable in 4 quarterly installments.
Determine the following:
a. Approximate annual interest rate.
b. Effective annual interest rate.

Problem 9.Jem Traders, Inc. needs P100,000 to pay a supplier’s invoices for a merchandise purchased with terms of 2/10, net 30. Jem Traders wants to pay
on the 10th day of the credit term so it can avail of 2% discount. The funds needed can be raised by obtaining a short-term loan from a bank which agrees to
grant a 30-day loan at 12% discounted interest per annum. The bank requires that a compensating balance of 10% be maintained in the borrower’s non-
interest earning deposit account.
a. The amount needed by Jem Traders to pay the invoice within the discount period is?
b. The principal amount of the loan that must be obtained from the bank to raise the needed fund is?
c. What is the effective interest rate of the loan?
d. If Jem Traders fails to pay the discount and pays the account on the 30th day of the term, what is the annual cost of this non-free trade credit?

Sample Problems for Financial Management 1 (Working Capital Management)

Problem 1. The records of JS Corporation and DV Corporation revealed the following data in relation to its operating activities in 2013 (in thousands):

JS Corporation DV Corporation
Net Cash Sales P 10,000 P 45,000
Net Credit Sales 190,000 240,000
Cost of goods sold 110,000 180,000
Net Cash purchases 5,000 20,000
Net credit purchases 96,000 112,000
Average Trade receivables 9,500 16,000
Average inventories 2,750 7,200
Average Trade payables 2,400 3,500
Cash operating cycles 18,000 17,600
Average Cash 600 800
Average Total Assets 80,000 95,000
Suppliers’ Credit Terms 2/10, n/30 2/10, n/30
Required: Compute for the following ratios for JS and DV Corporation in 2013 (use a 360 day year.)
1. Inventory turnover
2. Inventory days
3. Receivable turnover
4. Collection period
5. Payable turnover
6. Payment period
7. Operating Cycle
8. Net Cash cycle
9. Net working capital
10. Working capital turnover

Problem 2. The LML Corporation opened two more dealerships in Cabanatuan City, Nueva Ecija and Lucena City, Quezon. All payments are in check, sent
by mail averaging about P420,000 per week. At present, these payments become available to LML Corporation on the sixth day, on the average, after the
check is written.
Required:
1. How much money is tied up during the float period?
2. The company is considering weekly pick-ups from the dealers to reduce the delay. In all. Two (2) cars will be needed and two (2) additional people
hired for a total cost of P60,000 per year This would reduce the delay for four (4) days. The present opportunity cost of funds to the company is
the average money market rate of 24% per year. Should the company undertake this plan?
3. A commercial bank with a large branch network offered to do the collection for the company through its Cabanatuan City and Lucena City
branches. This procedure will reduce the delay for 2 days and will cost the company about P45,000 annually in telecommunications and
collections charges. Should the company accept the offer?

Problem 3. The Madatung Company plans to have P1 million in steady cash outlays for next year. The firm believes that it will face an opportunity interest
rate of 15% and will incur a cost of P200 each time it borrows (or withdraws).
Required: Using the Baumol Model
1. Determine the transactions demand for cash (the optimal borrowing or withdrawal) for Madatung Company.
2. What will be the cash balance for the firm (in days)?
3. What would be the average cash cycle for the firm?
4. Compute for the total relevant cost of cash balance.

Problem 4. An aggressive credit manager has taken over Salvation Corporation. Currently, sales are about P21.6 million a year. The credit manager
believes that by establishing a credit terms of 2/10, n/30, he can reduce the collection period from 60 days to 10 days, on average. The credit manager
expects that 80% of the credit customers will take advantage of the discount and that all of the funds received from the receivables can be invested at 15%.
Moreover, the company expects to reduce its collection by P90,000 a year on this new credit policy.
Required: Using a 360-day year, determine the following:
1. Receivables turnovers before and after the change in credit policy.
2. Average receivable balances before and after the change in the credit policy.
3. Net advantage (disadvantage) of the new credit policy.

Problem 5. Lito Corporation has been buying product A in lots of 1,200 units which represents a four month’s supply. The cost per unit is 220. The order cost
is P200 per order; and the annual inventory carrying cost per one unit is P25. Assume that the units will be required evenly throughout the year.
Required:
1. EOQ
2. Number of orders in a year
3. Average inventory based on economic order quantity.
4. Total carrying cost, ordering costs, and relevant inventory costs at economic order quantity.

Problem 6. Pacaldo Shoe Corporation needs 40,000 units of material FJM in a year. The average carrying cost per unit of material is P5 and the set-up cost
per production run is P40. The units are used evenly throughout the period.
Required:
1. Economic production run
2. Number of production set-up in a year
3. Average inventory based on economic order quantity.
4. Total carrying cost, ordering costs, and relevant inventory costs at economic production quantity.

Problem 7. The “I Shall return” Company has an inventory conversion period of 60 days, a receivable conversion period of 30 days. The company’s variable
cost ratio is 60 percent the opportunity cost for Camp is 12%. If annual sales are P 3,375,000 and all sales are on credit, what is the firm’s carrying cost on
accounts receivable, using 360 days year?

Problem 8. “Forget me Not” Company sells on terms 3/10, net 30. Total sales for the year are P900,000. Forty percent of the customers pay on the tenth
day and take discounts; the other 60 percent pay, on average, 45 days after their purchases. What is the average amount of receivables?

NOTE: An objective of accounts receivable is to have both the optimal amounts of receivables outstanding and bad debts. This balance requires the trade-
off between the benefit of more credit sales and the cost of accounts receivables, such as collection, interest and cost of bad debts.

Problem 9. Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to speed collections. At present, 40 percent
of Sonata Company‘s customers take the 2 percent discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless of
the credit terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change
does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their present 2 percent level. However, the more
generous cash discount terms are expected to increase sales from P2 million to P2.6 million per year. Sonata Company’s variable cost ratio is 75 percent,
the interest rate on funds invested in accounts receivable is 9 percent, and the firm’s income tax rate is 40 percent.
1. What are the days sales outstanding (DSO) before and after the change of credit policy?
2. The incremental carrying cost on receivable is?
3. The incremental after tax profit from the change in credit terms is?
Sample Problems for Financial Management 1 (Financial Forecasting)

Financial Position (2012), in millions of pesos Income statement (2012), in millions of pesos

Key ratios Key assumptions

Question:
1. Determining additional funds needed, using the AFN equation
2. How shall AFN be raised, if:
The payout ratio will remain at 30 percent (d = 30%; RR = 70%).
No new common stock will be issued.
Any external funds needed will be raised as debt, 50% notes payable and 50% L-T debt.