Cash and Marketable Securities Seatworks

1. Cash float. The ABC Corporation opened two more dealerships in New York City and Toronto. All
payments by these dealers are in check sent by mail, averaging about P420,00 per week. At
present, these payments become available to LML Corporation on the sixth day, on the average,
after the check is written.

Required:

• How much money is tied up during the float period?

• 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 by 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?
• A commercial bank with a large branch network offered to do the collection for the company
through its New York and Toronto branches. This procedure will reduce the delay by 2 days and
will cost the company about P45,000 annually in telecommunications and collection charges.
Should the company accept the offer?

2. Effective interest loan rate. ABC Company is arranging for a P 500,000 one- year loan from
People's Bank. The bank has offered ABC Company the following alternatives:

a. A 30% interest rate loan, no required compensating balance, and principal plus interest due
at the end of the year.
b. A 19% interest rate loan, with 20% compensating balance, and principal plus interest due at
the end of the year.
c. A 21 % interest rate loan, with 20% compensating balance, and principal plus interest due at
the end of the year; the compensating balance earns an interest of 8% per annum.
d. A 16% interest rate loan, with 15% compensating balance and the interest deducted from the
principal at the time of loan release, i.e., discounted. Principal due at the end of the year.
e. An 18% interest rate loan, with 15% compensating balance and the interest deducted from
the principal at the time of loan release, i.e., discounted. Principal due at the end of the year;
the compensating balance earns an interest of 9% per annum.
f. An 18% discounted interest rate loan, with 15% compensating balance, principal due at the
end of the year; the compensating balance earns an interest of 9% per annum.
g. An 18% discounted interest rate loan, with l. 5% compensating balance, principal due at the
end of the year;' the compensating balance earns an interest of 9% per annum; the company
currently maintains a compensating cash balance of P50,000.

Required:
• Calculate the effective interest loan rate for each of the alternatives offered by the
bank.
• Determine the best alternative offered by the bank of which you would recommend to
ABC Company to avail of.
3. Optimal cash balance. The ABC Corporation 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 P 200 each time it borrows (or withdraws).

Required: Using the Baumol model:

• Determine the transactions demand for cash (the optimal borrowing or withdrawal lot size)
for ABC Company.
• What will be the cash cycle for the firm (in days)?
• What would be the average cash balance for the firm?
• Compute the total relevant cost of cash balance.

4. Working capital requirements. ABC Company is planning to build a new plant in Tarlac City. The
plant is expected to provide additional sales as follows:

First year P 2.0 million

Second year 2.5 million

Third year 3.0 million (maximum capacity)

The financial manager of ABC estimates that for every peso of sales, P0.25 must be invested in
current assets. if all discounts are taken and bills are paid on time, accounts payable average P0.04
per peso of sales. Other current liabilities, such as wages payable, typically average P0.05 per peso
of sales.

Required:

• Estimate the working capital investments required for the new plant in the first year, second
year and third year of operations.
• How do these requirements affect the associated cash flows and the viability of the project?

5. Factoring. The AJ Company has been negotiating with the Metro-Bank with the hope of finding a
cheaper source of funds than their current factoring arrangements. Forecasts indicate that, on
average, they will need to borrow P 180,000 per month this year - which is approximately 30
percent more than they have been borrowing on their receivables during the past year. Sales
are expected to average P900,000 per month, of which 70 percent are on credit.

As an alternative to the present arrangements, Metro-Bank has offered to lend the company up
to 75 percent of the face value of the receivables shown on the schedules of accounts. The bank
would charge 15 percent per annum plus a 2 percent processing charge per peso of receivables
assigned to support the loans. AJ Company extends terms of net 30 days, and all customers who
pay their bills do so by the 30th of the month.

The company's present factoring arrangement costs them a 2-1/2 percent present factor fee
plus an additional 1-1/2 percent per month on advances up to 90 percent of the volume of
credit sales. AJ Company saves P 2,500 per month that would be required to support a credit
department and a l- 1/4 percent bad debt expenses on credit sales

Required:

• Calculate the expected monthly cost of the bank financing proposal.

• Calculate the expected monthly cost of factoring.
• Discuss three advantages of factoring.
• Discuss the disadvantages of factoring.
• Would you recommend that the firm discontinue or reduce its factoring arrangement in
favor of Metro-Bank's financing plan? Explain your answer.