Professional Documents
Culture Documents
Chapter 4 Financing Current Assets
Chapter 4 Financing Current Assets
Financing
Current Assets
1
Working Capital Financing Policy 2
• The manner in which the permanent and
temporary working capital are financed is
called the firm’s working capital /current
assets/ financing policy.
• Two sources from which funds can be
raised for working capital investment: (i)
short term sources (current liabilities),
and (ii) long-term sources such as share
capital and long-term debt.
Three alternative working capital (current 3
assets) financing policies.
•Maturity matching,
•Aggressive and
•Conservative
Maturity Matching Financing
Policy 4
• A policy by which a firm finances its
temporary current assets with short term
financing whereas
• The permanent component of current assets
and all fixed assets would be financed with
long-term debt and equity capital.
• Expected profits and risk level of this policy
are between the aggressive and the
conservative policies.
5
Aggressive Financing Policy
6
$ Temp. C.A.
S-T
Loans
Years
Lower dashed line would be more aggressive.
Conservative financing policy
Marketable
$ securities
Zero S-T
Debt
L-T Fin:
Perm C.A. Stock,
Bonds,
Spon. C.L.
Fixed Assets
Years
Short-term credit
• Any debt scheduled for repayment within one
year.
• Major sources of short-term credit
• Accounts payable (trade credit)
• Bank loans
• Commercial loans
• Accruals
• From the firm’s perspective, S-T credit is
more risky than L-T debt.
• Always a required payment around the corner.
• May have trouble rolling over loans.
Advantages and disadvantages
of using short-term financing
• Advantages
• Speed
• Flexibility
• Lower cost than long-term debt
• Disadvantages
• Fluctuating interest expense
• Firm may be at risk of default as a result of
temporary economic conditions
Accrued liabilities
16-22
Effective cost of trade credit
INPUTS 1 92 0 -100
N I/YR PV PMT FV
OUTPUT 8.6957
Raising necessary funds with a
discount interest loan
• Under the current scenario, $100,000 is
borrowed but $8,000 is forfeited because it
is a discount interest loan.
• Only $92,000 is available to the firm.
• If $100,000 of funds are required, then the
amount of the loan should be:
Amt borrowed = Amt needed / (1 –
discount)
= $100,000 / 0.92 = $108,696
Discount interest loan with a
10% compensating balance
Amount needed
Amount borrowed =
1 - discount - comp. balance
$100,000
= = $121,951
1 - 0.08 - 0.1
16-30
Add-on interest on a 12-month
installment loan
• Interest = 0.08 ($100,000) = $8,000
• Face amount = $100,000 + $8,000 = $108,000
• Monthly payment = $108,000/12 = $9,000
• Avg loan outstanding = $100,000/2 = $50,000
• Approximate cost = $8,000/$50,000 = 16.0%
• To find the appropriate effective rate, recognize that
the firm receives $100,000 and must make monthly
payments of $9,000. This constitutes an annuity.
Installment loan
From the calculator output below, we have:
kNOM = 12 (0.012043)
= 0.1445 = 14.45%
INPUTS 12 100 -9 0
N I/YR PV PMT FV
OUTPUT 1.2043
What is a secured loan?