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Short-term Financing
Sources of Short-Term Financing Cost
1. Spontaneous Source of Financing – use cash by delaying cash disbursement
Cost of failing to take a cash discount

a. Simple
= Percentage Discount
X 365
100% - Percentage Discount Credit Period - Discount Period
b. Compounded
= [(
1+
Percentage Discount
X X
100% - Percentage Discount
) 365
]
Credit Period - Discount Period
2. Commercial Bank Loan Financing
a. Amount to be Borrowed (Principal)

= Amount needed (Net Proceeds)
(1 - Compensating balance % - Interest %)
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= Net Proceeds (P)
Net Proceeds (%)
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b. Cost of Commercial Bank Financing
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= InterestX Days in the year (360)
Principal
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Days loan is outstanding
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c. Effective Interest on discounted loan
= Interest X Days in the year (360)
Principal - Interest Days loan is outstanding
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d. Effective Interest on discounted loan with Compensating Balance

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Interest expense – Interest income Days in the year (360)

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= X
Principal - Interest – Compensating Balance* Days loan is outstanding
*deduct issue cost if any.

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Secured Sources of Financing

1. AR financing – assignment
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2. Inventory financing – collateral of inventory
Leverage
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DOL = CM DFL = EBIT DCL = CM

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EBIT EBT EBT
DOL – try to manipulate sales units to increase total sales

DFL – generate income from borrowed funds. It is used only if net income is sufficient to
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cover interest.
Review Questions
1. Donner Co. intends to acquire a new equipment to increase its capacity. It is estimated
to cost P2.4M. A bank can finance the acquisition at 10% discounted interest.
Alternatively, the company may just delay payment to its suppliers. Presently, the
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company buys under terms of 2/10, net 40, but management believes payment count be
delayed 30 additional days, without penalty; that is payment could be made in 70 days.
Assuming 360 days, what should the company do? Borrow - CBLF 11.11% SSF – 12.24%
1. Bridgeport Inc has a P30 million revolving credit agreement with its bank at prime plus
3.2% based on a calendar year. Prior to the month of April, it had taken down P15
million that was outstanding for the entire month. On April 10, it took down another P5
million. Prime is 8.2%, and the bank's commitment fee is 0.25% annually. Calculate the
total charges associated with Bridgeport's revolving credit agreement for the month of
April.
a. P174,167
b. P2,427
c. P176,594
d. P171,740
2. Southport Inc. has an inventory turnover of 10x, a DSO of 45 days, and turns over its
payables once a month. How long is Southport's cash conversion cycle? (Use a 360-day
year.)
a. 36 days; 45 days
b. 81 days; 45 days
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c. 81 days; 51 days
d. 51 days; 36 days
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3. Dexter Instrument Company's sales average P3 million per day. If Dexter could reduce
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the time between customers' mailing their payments and the funds' becoming collected
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balances by 2.5 days, what would be the increase in the firm's average cash balance?
a. P3.5M
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b. P5.5M
c. P6M
d. P7.5M
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4. Dexter Instrument Company's sales average P3 million per day. Dexter could reduce the
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time between customers' mailing their payments and the funds' becoming collected
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balances by 2.5 days to increase in the firm's average cash balance. Assuming that these
additional funds can be invested in marketable securities to yield 8.5 percent per year,
determine the annual increase in Dexter's (pretax) earnings.
a. P750,000
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b. P637,500
c. P250,000
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d. P857,500
5. Miranda Tool Company sells to retail hardware stores on credit terms of "net 30."
Annual credit sales are P18 million and are spread evenly throughout the year. The
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company's variable cost ratio is 0.70, and its accounts receivable average P1.9 million.
Using this information, determine the average daily credit sales (assume there are 365
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days per year).

a. P49,315
b. P5,205
c. P570,000
sh
d. P46,719
6. Miranda Tool Company sells to retail hardware stores on credit terms of "net 30."
Annual credit sales are P18 million and are spread evenly throughout the year. The
company's variable cost ratio is 0.70, and its accounts receivable average P1.9 million.
Assume there are 365 days per year. Using this information, what is the days sales
outstanding?
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a. 36.5
b. 38.5
c. 39
d. 45
7. The Milton Company currently purchases an average of P22,000 per day in raw
materials on credit terms of "net 30." The company expects sales to increase
substantially next year and anticipates that its raw material purchases will increase to
an average of P25,000 per day. Milton feels that it may need to finance part of this sales
expansion by stretching accounts payable. Assuming that Milton currently waits until
the end of the credit period to pay its raw material suppliers, what is its current level of
trade credit? (Assume a 365-day year when converting from annual to daily amounts or
vice versa.)
a. P750,000
b. P660,000
c. P90,000
d. P364,999
8. The Milton Company purchases an average of P22,000 per day in raw materials on
credit terms of "net 30," and expects sales to increase substantially next year, increasing
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its raw material purchases to an average of P25,000 per day. Milton feels that it may
er as
need to finance part of this sales expansion by stretching accounts payable. Assume that
Milton currently waits until the end of the credit period to pay its raw material suppliers,
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and find its current level of trade credit. (Assume a 365-day year when converting from
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annual to daily amounts or vice versa.) Now, if Milton stretches its accounts payable an
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extra 10 days beyond the due date next year, how much additional short-term funds (that
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is, trade credit) will be generated?
a. P340,000
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b. P220,000
c. P250,000
d. P660,000
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9. The Pulaski Company has a line of credit with a bank under which it can borrow funds at
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an 8% interest rate. The company plans to borrow P100,000 and is required by the bank
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to maintain a 15% compensating balance. What is the annual financing cost of the loan if
the company currently maintains P7,000 in its bank account that can be used to meet
the compensating balance requirement. (Assume a 365-day borrowing period.)
a. 7.6%
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b. 8.0%
c. 8.7%
ar stu
d. 9.2%
10. The Pulaski Company has a line of credit with a bank under which it can borrow funds at
an 8% interest rate. The company plans to borrow P100,000 and is required by the bank
is
to maintain a 15% compensating balance. Determine the annual financing cost of the
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loan if the company currently has no funds in its account at the bank that can be used to
meet the compensating balance requirement. (Assume a 365-day borrowing period.)
a. 9.41%
b. 8.50%
c. 17.6%
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d. 7.41%
11. Perry Chemicals is in the process of constructing a financial plan for the coming year. It
has estimated that fixed assets will be equal to P200,000,000 for the year and that
current asset requirements vary between a minimum of P50,000,000 and a maximum of
P80,000,000 during the year. What is the amount of permanent assets?
a. P30,000,000
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b. P130,000,000
c. P150,000,000
d. P250,000,000
12. Perry Chemicals is in the process of constructing a financial plan for the coming year. It
has estimated that fixed assets will be equal to P200,000,000 for the year and that
current asset requirements vary between a minimum of P50,000,000 and a maximum of
P80,000,000 during the year. What is the amount of maximum temporary assets?
a. P30,000,000
b. P130,000,000
c. P150,000,000
d. P250,000,000
13. What is the nominal annual cost of trade credit given payment terms offering a 3%
discount if payment is received 15 days after purchase or payment in full is due in 45
days (Assume 360 days per year)?
a. 36%
b. 37.11%
c. 45.03%
d. 30%
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14. Rhine River Products is considering changing to a cash management system that would
reduce its mail delay from 3 days to 1 day and totally eliminate its processing delay of 2
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days. On average, the firm collects P75,000 of credit sales per day. The firm's marginal
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tax rate is 46%, and its required rate of return on the system is 15%. What amount of
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funds would be made available if Rhine River switched to the proposed system?
a. P300,000
b. P18,750 rs e
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c. P11,250
d. P345,000
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15. Rhine River Products is considering changing to a cash management system that would
reduce its mail delay from 3 days to 1 day and totally eliminate its processing delay of 2
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days. On average, the firm collects P75,000 of credit sales per day. The firm's marginal
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tax rate is 46%, and its required rate of return on the system is 15%. What
compensating balance requirement would the firm be willing to accept if the system is
implemented?
a. P300,000
ed d
b. P18,750
ar stu
c. P11,250
d. P345,000
16. Pentec Electric is in the process of forecasting accounts receivable. However, the
company is unsure of the amount of credit sales and whether the days sales outstanding
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will be 30 or 40 days. If annual credit sales are P45 million, what is the balance in
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accounts receivable for a DSO of 30 and a DSO of 40 (Assume 360 days per year)?
a. P3,750,000; P5,000,000
b. P5,000,000; P1,500,000
c. P1,500,000; P1,125,000
d. P5,125,000; P3,750,000
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17. Pentec Electric is in the process of forecasting accounts receivable. However, the
company is unsure of the amount of credit sales and whether the days sales outstanding
will be 30 or 40 days. If annual credit sales are P60 million, find the balance in accounts
receivable for a DSO of 30 and a DSO of 40.
a. P3,750,000; P5,000,000
b. P5,000,000; P6,500,000
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c. P5,000,000; P6,666,667
d. P5,125,000; P6,666,667
18. In order to attract new customers, Media Technique is considering changing its credit
terms from net 30 to net 60. Currently, Media's days sales outstanding is 40 days and is
expected to increase to 70 days if the terms are extended to net 60. The liberal credit
period is expected to add P30,000,000 in new annual sales to the current sales level of
P150,000,000. What is Media's current balance in accounts receivable (Assume 360 days
per year)?
a. P120,000,000
b. P375,000
c. P16,666,667
d. P41,666,667
19. In order to attract new customers, Media Technique is considering changing its credit
terms from net 30 to net 60. Currently, Media's days sales outstanding is 40 days and is
expected to increase to 70 days if the terms are extended to net 60. The liberal credit
period is expected to add P30,000,000 in new annual sales to the current sales level of
P150,000,000. What will Media's balance in accounts receivable be if the longer credit
period is made effective (Assume 360 days per year)?
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a. P35,000,000
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b. P29,166,667
c. P5,833,333
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d. P10,500,000
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20. The York Company has an average receivables balance of P55,000, which turns over
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once every 30 days. It offers all of its receivables to its bank as collateral for short-term
borrowing (pledging). The bank generally accepts 60% of the accounts offered and
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advances cash equal to 85% of those. Interest is 3% over prime and the bank charges a
1% administrative fee on the gross value of all accounts offered. The prime rate is
currently 9.5%. What effective rate is York paying for its receivables financing (Assume
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360 days per year)?

a. 12.5%
aC s
b. 18.4%
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c. 23.5%
d. 36.0%
21. Peterson Electronics is considering using wire transfers instead of depository transfer
ed d
checks in moving funds from the six collection centers to its concentration bank. Wire
transfers would reduce the elapsed time by 3 days. Depository transfer checks cost
ar stu
P0.50 (including postage), and wire transfers cost P10. Assume there are 250 working
days per year. Peterson can earn 7 percent before taxes on any funds that are released
through more efficient collection techniques. What is the net (pretax) benefit to Peterson
of using wire transfers if annual sales are P15 million (Assume 360 days per year)?
is
a. -P8,630
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b. -P5,620
c. P14,250
d. P5,620
22. Pyramid Products Company has a revolving credit agreement with its bank with which
sh
the company can borrow up to P1 million at an annual interest rate of 9%. Pyramid is
required to maintain a 10% compensating balance on any funds borrowed under the
agreement and to pay a 0.5% commitment fee on the unused portion of the credit line.
Assume that Pyramid has no funds in the account at the bank that can be used to meet
the compensating balance requirement. Determine the annual financing cost of
borrowing P250,000 under the credit agreement. (Assume a 365-day borrowing period.)
a. 15.32%
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b. [10.4%
c. 11.67%
d. 12.41%
borrowing P500,000 under the credit agreement. (Assume a 365-day borrowing period.)
a. 11.67%
b. 14.22%
c. 9.56%
d. 10.56%
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borrowing P1,000,000 under the credit agreement. (Assume a 365-day borrowing
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period.)
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a. 11.67%
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b. 10.00%
c. 12.56%
d. 10.56% rs e
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25. The Odessa Supply Company is considering obtaining a loan from a sales finance
company secured by inventories under a field warehousing arrangement. Odessa would
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be permitted to borrow up to P300,000 under such an arrangement at an annual interest

rate of 10%. The additional cost of maintaining a field warehouse is P16,000 per year.
aC s
What will be the annual financing cost of a loan under this arrangement if Odessa
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borrows the P300,000?

a. 11.6%
b. 12.6%
c. 15.3%
ed d
d. 18.7%
ar stu
26. The Odessa Supply Company is considering obtaining a loan from a sales finance
company secured by inventories under a field warehousing arrangement. Odessa would
be permitted to borrow up to P300,000 under such an arrangement at an annual interest
rate of 10 percent. The additional cost of maintaining a field warehouse is P16,000 per
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year. Determine the annual financing cost of a loan under this arrangement if Odessa
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borrows P250,000.
a. 14.7%
b. 10.0%
c. 15.6%
d. 16.4%
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27. Classic Computers' current assets are expected to reach their highest level of
P46,300,000 in June and their lowest level of P28,000,000 in December. Classic's fixed
assets will remain constant at P75,000,000 and owner's equity is P46,000,000.
Spontaneous liabilities are expected to average 30% of current assets. Classic has
established a working capital policy of financing 50% of its maximum temporary assets
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with permanent financing. What is the amount of permanent assets? The maximum
temporary assets?
a. P103,000,000; P20,000,000
b. P74,600,000; P27,000,000
c. P74,000,000; P103,000,000
d. P103,000,000; P74,000,000
with permanent financing. What is the amount of permanent financing? The amount of
long-term debt?
a. P123,000,000; P103,000,000
b. P113,000,000; P58,600,000
c. P103,000,000; P58,600,000
d. P159,000,000; P103,000,000
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with permanent financing. What is the amount of temporary financing? The amount of
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negotiated current liabilities?
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a. P43,000,000; P20,000,000
b. P10,000,000; P4,000,000
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c. P43,000,000; P10,000,000
d. P28,000,000; P4,000,000
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30. Baltic Compounds' financial managers estimate that the firm will require P1.5 million in
short-term financing over the coming year. How large a loan should the managers obtain
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from the firm's bank if the loan calls for discount interest with a stated interest rate of
vi y re
10%?
a. P1,666,667
b. P1,350,000
c. P150,000
ed d
d. P666,667
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from the firm's bank if the loan calls for simple interest with a stated interest rate of
10% and a 15% compensating balance requirement?
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a. P1,666,667
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b. P1,764,706
c. P1,350,000
d. P1,275,000
sh
from the firm's bank if the loan is a discount loan with a 10% stated rate and a 15%
compensating balance requirement?
a. P1,666,667
b. P1,764,706
c. P2,000,000
d. P1,125,000
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33. Raleigh Manufacturing needs P5.0 million short-term credit for 90 days. The firm
intends to sell commercial paper with a discount interest rate of 15%, dealer placement
fees of P75,000, and other flotation costs of P15,000. How large should the commercial
paper issue be (Assume 360 days per year)?
a. P5,090,000
b. P5,288,312
c. P5,015,000
d. P3,817,500
34. Raleigh Manufacturing needs P5.0 million short-term credit for 90 days. The firm
intends to sell commercial paper with a discount interest rate of 15%, dealer placement
fees of P75,000, and other flotation costs of P15,000. What are the issue's nominal
annual interest rate and the effective annual interest rate (Assume 360 days per year)?
a. 23.1%; 25.2%
b. 25.2%; 23.1%
c. 15.1%; 25.2%
d. 25.2%; 15.1%
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rs e
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ed d
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is
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Short-term Financing

Sources of Short-Term Financing Cost

1. Spontaneous Source of Financing – use cash by delaying cash disbursement

Cost of failing to take a cash discount

2. Commercial Bank Loan Financing

a. Amount to be Borrowed (Principal)

d. Effective Interest on discounted loan with Compensating Balance

Interest expense – Interest income Days in the year (360)

*deduct issue cost if any.

Secured Sources of Financing

2. Inventory financing – collateral of inventory

DOL = CM DFL = EBIT DCL = CM

EBIT EBT EBT

DOL – try to manipulate sales units to increase total sales

days per year).

360 days per year)?

be permitted to borrow up to P300,000 under such an arrangement at an annual interest

borrows the P300,000?

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