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Chapter 17 Short Term Credit For Financiang Current Assets PDF
Chapter 17 Short Term Credit For Financiang Current Assets PDF
CHAPTER 17
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 17 Short-term Credit for Financing Current Assets
Supporting computations:
5.
Approx. cost = Discount % x 360
Days credit is
100 - Discount % − Discount
outstanding period
= 2% x 360= 2x 360
100% - 2% 40 - 10 98 30
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Short-term Credit for Financing Current Assets Chapter 17
=24.5%
6.
= = 0.1111 = 11.11%
Effective rate on the Interest
discount loan Face value − Interest
Credit terms are 2/10, net 40, but delaying payments 30 additional days is
the equivalent of 2/10, net 70. Assuming no penalty, the approximate cost
(P2,400,000) (0.10)
is as follows:
P2,400,000 − (P2,400,000) (0.10)
Discount %P240,000 360
Approx. cost = 100 - Discount % x
Days credit is
P2,160,000 − Discount
outstanding period
2% 360 2 360
= x = x
100% - 2% 70 - 10 98 60
=12.24%
Therefore, the loan cost is 1.13 percentage points less than trade credit.
7.
= =
= 11.1%
9.
= = 13.3%
= P13,333,
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Chapter 17 Short-term Credit for Financing Current Assets
P10,000 = = 12.67%
1 − 0.15 − 0.10
P10 million + P125,000 1
24. P200 million − P125,000 − P10 million 180 / 360
= 8.67%
26.
= = = .0959
RATE = x
= 46%
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Short-term Credit for Financing Current Assets Chapter 17
RATE = x
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.
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
c.
= .12 x x P500,000
= P10,000
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Chapter 17 Short-term Credit for Financing Current Assets
RATE = x
a.
RATE = x
RATE = x
= .20, or 20%
c. P10,000 + P3,750 12
P500,000 2
RATE = x
= .21212, or 21.212%
= x
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Short-term Credit for Financing Current Assets Chapter 17
P5,500 360
P300,000 60
= x = 2.04% x 8 = 16.32%
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.
P300,000 P300,000 P300,000
PROBLEM 5 (1 (READY
− C) FLASHLIGHTS,
(1 − .20) INC.) .80
a. Effective rate of interest = x
= 1.83% x 6 = 10.98%
P6,850 360
P375,000 − P75,000 60
b. Cost of lost discount= x
P6,850
Cost of not taking a = 2.04%
P300,000
Discount % x 6 = 12.24%360
cash discount 100% − Disc.% Final due date-
c. Yes, because the cost of borrowing is less than the cost ofperiod
Discount losing the
discount.
2% 360
d. 98% = − 10)
(55 =
= x 6 = 2.28% x 6
= 13.68%
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Chapter 17 Short-term Credit for Financing Current Assets
Northeast Bank
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
Northeast Bank
= 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.
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:
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Short-term Credit for Financing Current Assets Chapter 17
b. The expected monthly cost of factoring is the sum of the interest cost and
the factor cost. The calculations are as follows:
Cost = x
The cost of each supplier must be weighted by the proportion of the total
Discount
provided by the supplier. 360 days
1.00 – Discount Credit period – Discount period
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
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 supplier’s 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%.
17-12