FERNANDEZ, ARIANNE KIM J.

| 204A

1. Optimal Cash Transfer (or Optimal Cash Balance). Antok Corporation has gathered the following data from its Treasury Department
at the end of 2014:
Annual cash need in 2014 P54 million
Cost per transaction P800
ROI on marketable securities 6%
Type equation here.
a. optimal cash transfer
c = SQRT 2 x T x F / R
= SQRT 2 x 54,000,000 x 800 / 6%
= 1,200,000

b. average cash transfer

Ave. cash transfer = annual cash needed / optimal cash transfer
= 54,000,000 / 1,200,000
= 45

c. total cash cost

c1. at the optimal cash balance.
Optimal cash balance = (1,200,000x 6%)/2 + (54,000,000 / 1,200,000) x 800
= 36,000 + 36,000
= 72,000

c2. at a P2 million denominated cash transfer.

2,000,000 denominated cash transfer = (2,000,000x 6%)/2 + (54,000,000 / 2,000,00) x 800
= 60,000 + 21,600
= 81,600

c3. at a P200,000 denominated cash transfer.

200,000 denominated cash transfer = (200,000x 6%)/2 + (54,000,000 / 200,000) x 800
= 6,000 + 216,000
= 222,000

2. Cash float.
a. Maximizing deposit float. Options Corporation has an average daily collection of P20 million. The company is considering to
accelerate its collections by 3 days by spending an annual amount of P24,000 in a new system. The effective interest rate of
marketable securities is 8%. How much would the company benefit from accelerating the collections?
Cost of new system = 24,000

Savings due to reduction in collection days = 20,000,000 x 3 days x 8%

= 4,800,000

Net benefit = 4,800,000 - 24,000

= 4,776,000

b. Optimizing payment float. Songbird and Chirp Company is considering the option of stretching its payment period to suppliers by
issuing checks on every Friday of the month instead of its current practice of issuing checks twice a week. This option would delay
payment by 3 days on the average. The company average daily payment is P400,000 and the prevailing benchmark rate of the 90-day
T-Bills is 8%. How much is the net benefit the company may generate from the alternative?
Net benefit due to delay in payment days = 400,000 x 3 days x 8%
= 96,000

3. Annual effective interest rate. Francia Inc., is shopping for a P80 million financing to support its working capital requirements. The
following data were gathered from several local banks with respect to interest terms, compensating balances, and other matters:

Bank 1 Bank 2 Bank 3 Bank 4 Bank 5

Nominal interest rate 12%, discounted14%, not discounted15%, not discounted 16%, discounted 14.5%, discounted
 FERNANDEZ, ARIANNE KIM J. | 204A

Interest payment Annually Annually Annually Annually Annually

Compensating Balance 1% 0.5% 5% None 1.5%
Present compensating none none P1.2million P2 million P1.2 million
balance
Interest income on
incremental 7% none 5% none none
compensating balance
Net interest expense 9,544,000 11,200,000 11,860,000 12,800,000 11,600,000
Net proceeds 78,000,000 79,600,000 77,200,000 67,200,000 78,800,000
Annual effective interest 12.05% 14.07% 15.36% 19.048% 13.20%
rate
Compounded annual EIR 12.738% 14.07% 15.36% 19.084% 13.20%

Required:
Complete the table above and determine the effective interest rates for each of the lending banks.
a. Which bank offers the most economical interest costs?
BANK 1
Interest expense = finance cost x nominal rate
= 80,000,000 x 12%
= 9,600,000

Interest income = inc in compensating bal x rate

= 80,000,000 x 1% - 0 x 7%
= 800,000 x 7%
= 56,000

Net interest expense = int. expense – int income

= 9,600,000 – 56,000
= 9,544,000

Finance Loan 80,000,000

Less: Inc in compensating bal (800,000)
Net proceeds 79,200,000

Annual EIR = Net interest / Net proceeds

= 9,544,000 / 79,200,000
= 12.05%

Periodic interest rate = Annual EIR / # of interest periods

= 12.05% / 12 mos /1
= 1.00417%

Compound Annual EIR = (1+PEIR)^n-1

= (1+0.0100417)^12-1
= 12.738%

BANK 2
Interest expense = finance cost x nominal rate
= 80,000,000 x 14%
= 11,200,000
 FERNANDEZ, ARIANNE KIM J. | 204A

Interest income = inc in compensating bal x rate

= 80,000,000 x 0.5% - 0 x 0%
= 400,000 x 0%
= 0

Net interest expense = int. expense – int income

= 11,200,000 – 0
= 11,200,000

Finance Loan 80,000,000

Less: Inc in compensating bal (400,000)
Net proceeds 79,600,000

Annual EIR = Net interest / Net proceeds

= 11,200,000 / 79,600,000
= 14.07%

Periodic EIR = Annual EIR / # of interest periods

= 14.07% / 1
= 14.07%

Compounded annual EIR = (1+PEIR)^n-1

= (1+0.014)^1-1
= 14.07%

BANK 3
Interest expense = finance cost x nominal rate
= 80,000,000 x 15%
= 12,000,000

Interest income = inc in compensating bal x rate

= 80,000,000 x 5% - (1.2M) x 5%
= 2,800,000 x 5%
= 140,000

Net interest expense = int. expense – int income

= 12,000,000 – 140,000
= 11,860,000

Finance Loan 80,000,000

Less: Inc in compensating bal (2,800,000)
Net proceeds 77,200,000

Annual EIR = Net interest / Net proceeds

= 11,860,000 / 77,200,000
= 15.36%

Periodic EIR = Annual EIR / # of interest periods

= 15.36% / 1
= 15.36%
 FERNANDEZ, ARIANNE KIM J. | 204A

Compounded annual EIR = (1+PEIR)^n-1

= (1+0.01536)^1-1
= 15.36%

BANK 4
Interest expense = finance cost x nominal rate
= 80,000,000 x 16%
= 12,800,000

Interest income = inc in compensating bal x rate

= 80,000,000 x 0% - (2M) x 0%
= 0

Net interest expense = int. expense – int income

= 12,800,000 – 0
= 12,800,000

Finance Loan 80,000,000

Less: Inc in compensating bal (12,800,000)
Net proceeds 67,200,000

Annual EIR = Net interest / Net proceeds

= 12,800,000 / 67,200,000
= 19.048%

Periodic EIR = Annual EIR / # of interest periods

= 19.048% / 1
= 19.048%

Compounded annual EIR = (1+PEIR)^n-1

= (1+0.19048)^1-1
= 19.048%

BANK 5
Interest expense = finance cost x nominal rate
= 80,000,000 x 14.5%
= 11,600,000

Interest income = inc in compensating bal x rate

= 80,000,000 x 1.5% - (1.2M) x 0%
= 1,200,000 x 0%
= 1,200,000

Net interest expense = int. expense – int income

= 11,600,000 – 1,200,000
= 10,400,000

Finance Loan 80,000,000

Less: Inc in compensating bal (1,200,000)
Net proceeds 78,800,000
 FERNANDEZ, ARIANNE KIM J. | 204A

Annual EIR = Net interest / Net proceeds

= 10,400,000 / 78,800,000
= 13.20%

Periodic EIR = Annual EIR / # of interest periods

= 13.20% / 1
= 13.20%

Compounded annual EIR = (1+PEIR)^n-1

= (1+0.1320)^1-1
= 13.20%

b. What is Bank 1’s effective interest rate if the interest payment is made on a monthly basis?
Interest expense = finance cost x nominal rate
= 80,000,000 x 12%
= 9,600,000

Interest income = inc in compensating bal x rate

= 80,000,000 x 1% - 0 x 7%
= 800,000 x 7%
= 56,000

Net interest expense = int. expense – int income

= 9,600,000 – 56,000
= 9,544,000

Finance Loan 80,000,000

Less: Inc in compensating bal (800,000)
Net proceeds 79,200,000

Annual EIR = Net interest / Net proceeds

= 9,544,000 / 79,200,000
= 12.05%

Periodic interest rate = Annual EIR / # of interest periods

= 12.05% / 12 mos /1
= 1.00417%

Compound Annual EIR = (1+PEIR)^n-1

= (1+0.0100417)^12-1
= 12.738%

4. Change in credit policy. Black Eye Peas Corporation, which has idle capacity, provides the following data:
Selling price per unit P80
Variable cost per unit P50
Fixed cost per unit P10
Annual credit sales 300,000 units
Collection period 60 days
 FERNANDEZ, ARIANNE KIM J. | 204A

Rate of return 16%

Bad debts losses 1%
Tax rate 40%
Black Eyes Peas is considering a change in credit policy that would relax its credit standards. The following information applies to the
proposal:
a. Sales will increase by 20%.
b. Collection period will increase to 90 days.
c. Bad debts losses will increase to 2% of sales.
d. Collections costs are expected to increase by P200,000.
e. The company uses the 360-day year factor.

Required: Should the company change its credit policy?

Inc. in Sales (300,000 x 80 x 20%) 4,800,000

Multiply by: variable cost ratio (50/80) 62.5%
Inc in variable cost 3,000,000

Inc investment in receivables = 3,000,000 x (90 days/360 days)

= 750,000

Inc investment in receivables 750,000

Multiply by: rate of return 16%
Cost of change in credit terms 120,000

Inc in sales 4,800,000

Multiply by: CM ratio (100%-62.5%) 37.5%
Inc in CM 1,800,000
LESS: Cost of change in credit term 120,000
Inc in bad debt losses (300k x 80 x 120% x20) –
(300k x 80 x 1%) 336,000
Inc in cost of collection 200,000
Total benefit of changing the credit term 1,144,000
Multiply by: (100% - tax rate) 60%
Net benefit of changing the credit term 686,400

Yes, the company could improve its credit policy because updating the current credit policy would result in a net gain of
P686,400.

5. Annual Effective discount rate. The following suppliers of SSS Corporation provide the following credit terms:

Terms Amount
A Company 2/10, n/30 P1,200,000
B Company 3/15. n/45 450,000
C Company 3/25, n/90 900,000

Required:
a. The annual EDR per supplier if the credit is treated as a:
1. single transaction (eg, simple EDR)
simple EDR = (365 / net days) x ((trade disc / (100% - trade discount))

A COMPANY
simple EDR = (365 / (30-10)) x ((2% / (100% - 2%))
= 18.25 x 2.04
= 37.24%

B COMPANY
simple EDR = (365 / 45-15) x ((3% / (100% - 3%))
 FERNANDEZ, ARIANNE KIM J. | 204A

= 12.167 x 3.092
= 37.63%

C COMPANY
simple EDR = (365 / 90-25) x ((3% / (100% - 3%))
= 5.62 x 3.092
= 17.37%

2. continuing transaction (eg, compounded EDR)

compounded EDR = (1+(trade discount / 100% - trade discount))^ 365/net days -1

A COMPANY
compounded EDR = (1+(2% / 100% - 2%))^365/20 -1
= 44.59%

B COMPANY
compounded EDR = (1+(3% / 100% - 3%))^ 365/30 -1
= 44.86%

C COMPANY
compounded EDR = (1+(3% / 100% - 3%)) ^ 365/65 -1
= 18.65%

b. The annual weighted average EDR of SSS Corporation.

A COMPANY 1,200,000
B COMPANY 450,000
C COMPANY 900,000
TOTAL 2,550,000

SUPPLIER A = 1,200,000 / 2,550,000

= 47.06%

SUPPLIER B = 450,000 / 2,550,000

= 17.65%

SUPPLIER C = 900,000 / 2,550,000

= 35.29%

Simple EDR, weighted average = (47.06% x 37.24%) + (17.65% x 37.63%) + (35.29% x 17.37%)
= 30.30%

Compounded EDR, weighed ave. = (47.06% x 44.59%) + (17.65% x 44.86%) + (35.29% x 18.65%)
= 35.48%

6. Fill in the blank. Use the data provided in each case to solve for the unknown. Use 360 days.

Credit Free credit Non-free credit No. of

Periodic EDR Annual EDR
Case terms days days periods

A 2/20, n/40 20 20 18 2.0408% 36.72%

 FERNANDEZ, ARIANNE KIM J. | 204A

3/20,
B 20 30 12 3.0928% 37.11%
n/50
4/10,
C 10 20 18 4.1667% 75.00%
n/30
Additional Problems:

16. The Electra Car Company purchases 20,000 units of a major component part each year. The firm's order
costs are P200 per order and the carrying cost per unit is P2 per year.

Required:
A. Compute the total inventory costs associated with placing orders of 20,000, 10,000, 5,000, and 1,000.
= (annual purchase / order qty) x (ordering cost + order qty) / 2 x carrying cost

20,000 = (20,000 / 20,000) x (200 + 20,000)/2 x2

= 20,200

10,000 = (20,000 / 10,000) x (200 + 20,000)/2 x2

= 10,400

5,000 = (20,000 / 5,000) x (200 + 20,000)/2 x2

= 5,800

1,000 = (20,000 / 1,000) x (200 + 20,000)/2 x2

= 5,000

B. Determine the EOQ for the component parts.

EOQ = sqrt (2 x annual purchase x order cost) / carrying cost
= sqrt (2 x 20,000 x 200) / 2
= 2,000

17. Ever Company is considering switching from level production to seasonal production in order to lower
very high inventory costs. Average inventory levels would decline by P300,000 but production costs would rise
about P40,000 because of additional start-ups and other inefficiencies. The firms cost of financing inventory
balances is 15%.

Required:
A.Should the firm switch to seasonal production? (ignore income taxes)
= (300,000 x 15%) – 40,000
= 45,000 – 40,000
= 5,000

Yes, because switching to seasonal output would save them at least 5,000.

B. At what interest rate would the cost of financing additional inventory under level production be equal to
the added production costs of seasonal production? (ignore income taxes)
 FERNANDEZ, ARIANNE KIM J. | 204A

= 40% / 300,000
= 13.33%

C. Answer (A) and (B) if the applicable income tax rate is 40 percent.
A & B are the same.