MANAGEMENT ADVISORY b.

P600,000
c. P60,000
SERVICES 11 d. none of the above
Current Assets Management Answer: b
2024 Topic: Stretching payables
Solution: Additional credit =
P20,000(30) = P600,000
jjaur😊jrtcbic 11. Melody Dairy has a line of credit with
its bank. The firm plans to borrow
Multiple Choice P400,000 at a rate of 10 percent. The bank
requires a 15 percent compensating
balance and the firm currently maintains
1.D
P20,000 in its account at the bank that can
2.C
be used to meet the compensating balance
3.B P1,000,000 X 12%
requirement. Determine the annual
= P120,000 savings
financing cost to Melody of this loan.
4.d
a. 11.1%
5.c
b. 10.0%
6.b
c. 11.8%
7. Calculate the annual financing cost of
d. none of the above
foregoing the cash discount if the credit
Answer: a
terms are 1/10, net 40.
Topic: Cost of bank loan with
a. 6.0 percent
compensating balance requirements
b. 9.2 percent
Solution: AFC = P40,000/P360,000 =
c. 15.3 percent
0.111
d. None of the above
Answer: d
12. Gooden Foods, Inc. has a revolving
Topic: Cost of trade credit
credit agreement with its bank under which
Solution: AFC = [1/(100 - 1)] [365 /
it can borrow up to P10 million at an
(40 - 10)] = 12.3%
annual interest rate of 12 percent. The
firm is required to maintain a 10 percent
8. Calculate the annual percentage rate of compensating balance on any funds
foregoing the cash discount if the credit borrowed under this agreement and to pay
terms are 1/10, net 40. a 0.5 percent commitment fee on the
a. 1.13 percent unused portion of the credit line.
b. 13.0 percent Determine the annual financing cost to
c. 20.1 percent Gooden Foods of borrowing P4 million.
d. 11.11 percent a. 13.3%
Answer: b b. 14.7%
Topic: Cost of trade credit c. 14.2%
Solution: APR = [1 + (1/99)]365/30 - 1 d. none of the above
= 13.0% Answer: c
Topic: Cost of bank loan with
9. Idaho Industries currently purchases an compensating balance requirements
average of P20,000 per day of raw Solution: AFC =[P4,000,000(0.12) +
materials. Idaho’s suppliers offer credit (P6,000,000)(0.005)]/P3,600,000 = 0.142
terms of "net 60" and the firm waits until
the end of the credit period to pay
13. Northwest Container Company is
suppliers. Determine Idaho Industries'
considering selling an issue of commercial
current level of trade credit (accounts
paper to finance its seasonal needs. A
payable).
commercial paper dealer has offered to sell
a. P 20,000
a P10 million issue maturing in 90 days at
b. P600,000
an interest rate of 10 percent per annum
c. P1,200,000
(deducted in advance). The dealer's fee
d. P200,000
for selling the commercial paper would be
Answer: c
P10,000. Determine the annual financing
Topic: Level of trade credit
cost of commercial paper financing to
Solution: A/P = P20,000(60) =
Northwest.
P1,200,000
a. 10.7%
b. 10.3%
10. Idaho Industries currently purchases c. 10.0%
an average of P20,000 per day of raw d. 9.3%
materials. Idaho’s suppliers offer credit Answer: a
terms of "net 60" and the firm waits until Topic: Cost of commercial paper
the end of the credit period to pay its Solution: AFC =
suppliers. Determine the additional trade {[P10,000,000(0.10)(90/365) +
credit that can be obtained by the firm if P10,000]/(P9,753,425 - P10,000)}
Idaho stretches its accounts payable an x 365/90
extra 30 days beyond the due date. = 0.107 or 10.7%
a. P1,800,000

1
14. Pressing Club Corporation can raise
needed short-term funds by pledging its
receivables. First Bank will lend Pressing
70 percent of the P2.5 million in pledged
receivables at 11.2 percent plus a service
fee that equals 0.75 percent of the amount
of the pledged receivables. Interest is
computed based on the amount of
receivables pledged. If Pressing's average
collection period is 55 days, what is the
annual financing cost for the pledged
receivables?
a. 2.7%
b. 18.3%
c. 23.1%
d. 11.2%
Answer: b bank
Topic: Cost of receivables pledging
Solution: AFC = [(P29,534 +
P18,750)/P1,750,000] x 365/55 = 0.183
15. Modern Textiles, Inc. is considering
factoring its receivables. The firm has
annual sales of P109.5 million. Its average
collection period is 73 days. Bad-debt
losses average 2% of sales and credit
department costs are P360,000 per year.
Both of these costs would be eliminated if
Modern Textiles factors its receivables.
The factor will charge a fee of 3.5% on all
receivables it purchases from the company.
The factor will advance up to 80% of the
value of the receivables at an annual
interest rate of 12%. Interest is deducted
from the amount of the advance.
Determine the annual financing cost to
Modern Textiles of factoring its receivables
and borrowing under this arrangement.
Assume 365 days in any calculations.
a. 22.3%
b. 20.1%
c. 13.5%
d. none of the above/cannot be determined
Answer: b 365/91 -1 = .0827
Topic: Cost of factoring receivables
Solution: Average level of receivables =
P109,500,000(73/365) P21,900,000
Less: Factoring commission =
0.035(P21,900,000) 766,500
Less: Reserve for returns =
0.2(P21,900,000) 4,380,000
Amount available before interest is deducted
P16,753,500
Less: Interest on advance =
0.12(P16,753,500)(73/365) 402,084
Amount advanced by factor
P16,351,416
Interest cost
P402,084
Factoring commission
P766,500
Less: Credit department
savings (per 73 days)
= P360,000 (73/365)
P72,000
Less: Bad-debt loss savings
(per 73 days)
= 0.02(P21,900,000)
P438,000
Net cost per 73 days
P658,584
AFC
(P658,584/P16,351,416)(365/73)
20.1%
16. RoTech Medical Corp. needs to borrow
P15 million pesos for 270 days. It can
borrow from its bank at its current interest
rate of 9.75% plus a requirement to keep a
10% compensating balance. RoTech
currently has a P400,000 balance with its
bank. An alternative for RoTech is to sell
commercial paper. The interest rate on the
paper is 9.55% and the dealer’s fee for
selling the paper is P22,500. Which source
has the least cost?
a. Bank loan: 10.02% vs. 10.49% for
paper
b. Bank loan: 10.02% vs. 10.75% for
paper
c. Commercial paper: 9.70% vs 10.02%
d. Commercial paper: 10.49% vs 10.52%
bank
Answer: d
Topic: AFC of short-term funds
Solution: Bank:
Interest cost = 15,000,000(0.0975)(270/365) =
P1,081,849
Bank AFC = P1,081,849 x 365 = 0.1052
P13,900,000 270
Commercial paper:
Interest cost = P15,000,000(0.0955)(270/365)
= P1,059,658
Usable funds = P15,000,000 - P1,059,658 =
P13,940,342
AFC = P1,059,658 + P22,500 x 365 = 0.1049
P13,940,342 270
17. Ikon obtained a loan for P50,000. If
loan requires a repayment of P51,000 in 91
days, what is the loan’s APR?
a. 8.0%
b. 8.48%
c. 8.27%
d. 8.19%
Answer: c
Topic: Cost of short-term funds
Solution: APR = (1 + 1,000/50,000)
Problems
1. Chubby Co. purchases pork on terms
3/15 net 60. Assuming 360 days a
year, what is the annual cost of trade
credit if the company pays on:
(a) day 15?
(b) day 20?
(c) day 30?
(d) day 40?
(e) day 50?
(f) day 60?
(g) day 70?
(a) 0%
(b) (3%/100%-3%)(360/20-15)=222.68%
(c) (3%/97%)(360/30-15)=74.23%
(d) (P3/P97)(360/40-15)=44.54%
(e) (P3/P97)(360/50-15)=31.81%
(f) (P3/P97)(360/60-15)=24.74%
(g) (P3/P97)(360/70-15)=20.24% and the
possibility of ruining credit standing
=
2 . Mime Theatrical Supply is in the process
of negotiating a line of credit with two local
2
 banks. The prime rate is currently 8 finance the new project. Compute the
percent. The terms follow: annual interest rate on the issue of
Bank Loan Terms commercial paper if the value of the
1st National 1 percent above prime commercial paper at maturity is
rate on a discounted P1,650,000. Assume 360 days in a year.
basis and a 20
percent compensating Answers: Interest paid = P1,650,000
balance on the face – 1,500,000 = P150,000
value of the loan. Annual interest rate =
2nd National 2 percent above prime (P150,000/P1,500,000) (360/90) = 40%
rate and a 15 percent Level of Difficulty: 3
compensating Learning Goal: 4
balance. Topic: Computing the Effective Interest
(a)Calculate the effective interest rate of Rate (Equation 15.3)
both banks.
(b)Recommend which bank’s line of credit 6. Ofel Industries has a line of credit at
Mime Theatrical Supply should accept. Manila Bank that requires it to pay 11%
Answers: interest on its borrowing and to maintain a
(a) 1st National Bank effective cost compensating balance equal to 15% of the
0.08  0.01 amount borrowed. Ofel borrowed P800,000
 0.1268 during the year under the agreement.
1  0.09  0.20 Compute the effective annual rate on the
2nd National Bank effective cost firm’s borrowings in ach of the following
0.08  0.02 circumstances
 0.1176 (a)The firm maintains no deposit balances
1  0.15
at the bank.
(b)Mime would choose the 2nd National
(b) The firm maintains P70,000 of deposit
Bank since it has the lowest effective
balances at the bank.
interest rate (11.76 percent).
(c) The firm maintains P150,000 of deposit
. balances at the bank.
3. A&A Company purchased a new machine
on October 20th, 2003 for P1,000,000 on a)Compensating balance
credit. The supplier has offered A&A terms requirement=P800,000 borrowed 
of 2/10, net 45. The current interest rate 15%=P120,000
the bank is offering is Amount of loan available for
16 percent. use=P800,000-P120,000=P680,000
(a)Compute the cost of giving up cash Interest paid=P800,000  11 %=P88,000
discount. Effective interest rate
(b)Should the firm take or give up the cash
discount? P800,000 x 11% _= P88,000 = 12.94%
(c)What is the effective rate of interest if P800,000 – P120,000 = P680,000
the firm decides to take the cash
discount by borrowing money on a (b)Additional balances required=P120,000-
discount basis? Assume 360 days in a P70,000=P50,000
year. Effective interest rate
Answers: P800,000 x 11% = P88,000 = 11.73%
(a) Cost of foregoing cash discount P800,000 – P50,000 = P680,000
0.02 360
   21% (c)Effective interest rate=11%
1  0.02 35
(b) Since the cost of foregoing cash (None of the P800,000 borrowed is
discount is greater than the bank’s interest required to satisfy the compensating
rate, the firm should take cash discount. balance requirement.)
(c) Interest = 1,000,000  0.16  (35/360)
= P15,555.56 The lowest effective interest rate occurs in
Effective rate situation (c), when Ofel has P150,000 on
deposit. In situations (a) and (b), the need
15,555.56 360
  16.25% to use a portion of the loan proceeds for
1,000,000  15,555.56 35 compensating balances raises the
borrowing cost.
4. General Aviation has just sold an issue
of 30-day commercial paper with a face 7. Louie Aristorenas obtained a P10,000,
value of P5,000,000. The firm has just 90 day bank loan at an annual interest rate
received P4,958,000. What is the effective of 15%, payable at maturity. (Assume 360
annual interest rate on the commercial days a year).
paper? a. What is the peso interest on the 90 day
Answer:{(P5,000,000 – loan?
P4,958,000)/P4,958,000}  12 = 0.1017 b. Find the effective 90 day rate on the
loan.
5. A&A Apple Company would like to c. What is the effective annual rate
manufacture and market a new packaging. assuming that the loan is rolled over every
A&A has sold an issue of commercial paper 90 days throughout the year?
for P1,500,000 and maturity of 90 days to

3
(a)Interest = (P10,000  0.15)  (90 
360)= P375 Answers:
(b) Effective 90 day rate = P375/P10,000 (a)Western National Bank (pledging)
= 3.75% P600,000/12 x .75 = P37,500 funds
4
(c)Effective annual rate = (1 + 0.0375) -1 available
= 15.87%
The effective annual interest rate when the Commodity Finance (factoring)
note is rolled over throughout the year on Average accounts receivable P50,000
the same terms is calculated on a (P600,000/12)
compound basis as follows, using Equation Less: Reserve (15%x P50,000) 7,500
Less: Factoring Commission 500
keff = [1 + (k/m)m - 1 (1%XP50,000)
Funds available for advance P42,000
Less: Interest on advance (1.5% 630
8. Bernardo Co. wants to establish a  P42,000)
borrowing agreement with a bank. The Proceeds from advance P41,370
bank’s term for a line of credit are 3.30% Western National effective
over the prime rate, and each year the interest rate = 13%
borrowing must be reduced to zero for a 30 Commodity Finance effective interest rate
day period. For an equivalent revolving
credit agreement , the rate is 2.80% over P630/P41,370 x 12 = 18.27%
prime with a commitment fee of 0.50% on
the average unused balance. With both
loans the required compensating balance is (b)
20% of the amount borrowed. Bernaldo Western National
has no deposits with the bank. The prime Annual interest cost ( 37,500 P4,875
rate is 8%. Both agreements has P4 million  0.13)
borrowing limits. The firm expects to Commodity Finance
borrow 42 million during the year. Annual interest cost ( P630  P 7,560
12)
a. What is the effective annual rate under Factor’s commission ( P500  6,000
the line of credit? 12)
b. What is the effective annual rate under Total Cost P13,560
the revolving credit agreement? –benefit of closing credit
department 10,000
Answers:
Net Cost P 3,560
(a) (0.08 + 0.033)  0.80 = 14.125%
(b) Effective annual interest rate =
Since the net cost of factoring receivables
P2,000,000x (0.08 + 0.028) +
is less expensive than pledging receivables
(0.005xP2,000,000/P2,000,000x0.08) =
and also provides more available funds,
14.25%
Giant Feeds, Inc. should choose
Commodity Finance.
The revolving credit account seems better,
since the cost of the two arrangements is
10. Chubby Co. is in a liquidity problem
the same; with a revolving loan
and needs P100,000 loan for a month. Its
arrangement, the loan is committed.
accounts receivable is at low levels but its
inventory is liquid therefore a good
9. Giant Feeds, Inc. is considering
collateral for a loan. The book value of
obtaining funding through advances
inventory is P300,000 of which P120,000 is
against receivables. Total annual credit
finished goods. Assume a 365-days a year.
sales are P600,000, terms are net 30 days,
and payment is made on the average of
1. City Wide Bank will make a P100,000
30 days. Western National Bank will
trust receipt loan against the finished
advance funds under a pledging
goods. The annual interest is 12% on
arrangement for 13 percent annual
outstanding balance plus a 0.25%
interest. On average, 75 percent of credit
administration fee imposed on the
sales will be accepted as collateral.
P100,000 initial loan amount. Because it
Commodity Finance offers factoring on a
will be liquidated as inventory is sold, the
nonrecourse basis for a 1 percent factoring
average amount owed over the month is
commission, charging
expected to be P75,000.
1.5 percent per month on advances and
2. Sun State Bank will lend P00,000
requiring a 15 percent factor’s reserve.
against a floating lien on the book value of
Under this plan,
inventory for the 1-month period at an
the firm would factor all accounts and close
annual interest rate of 13%.
its credit and collections department,
3. Citizen’s Bank will lend P100,000
saving P10,000 per year.
againts a warehouse receipt on the finished
goods inventory and charge 15% annual
(a) What is the effective interest rate and
interest on the outstanding loan balance. A
the average amount of funds available
0.5% warehousing fee will be levied
under pledging and under factoring?
against the average amount borrowed.
(b) Which plan do you recommend? Why?
Because the loan will liquidate as inventory

4
is sold, the average loan balance is
expected to be P60,000.

Requirements:
a. Compute the peso cost of each proposed
plan .
b. Which is recommended/ Why?
c. If the firm made a purchase of P100,000
for which it had been given terms of 2/10
net 30, would it increase the firm’s
profitability to give up the discount and not
borrow? Why?

(a)City-Wide Bank: [P75,000  (0.12 

12)] +(0.0025  P100,000) = P1,000
Sun State Bank: P100,000  (0.13 
12) = P1,083
Citizens’ Bank and Trust: [P60,000 
(0.15  12)] + (0.005  P60,000) = P1,050
(b)City-Wide Bank is the best alternative,
since it has the lowest cost.
(c)Cost of giving up cash discount = (0.02
 0.98)  (365  20) = 37.24%
The effective cost of taking a loan =
(P1,000  P75,000)  12 = 16.00%
Since the cost of giving up the discount
(37.24%) is higher than borrowing at
Citywide Bank (16%), the firm should
borrow to take the discount.

Trust receipt inventory loans are often

made by manufacturers’ financing
subsidiaries to their customers. Under this
arrangement, merchandise is typically
expensive (automotive, industrial and
consumer-durable equipment, for example)
and remains in the hands of the borrower.
The lender advances 80 to 100% of the
cost of the salable inventory. The borrower
is free to sell the merchandise and is
trusted to remit the loan amount plus
accrued interest to the lender immediately.
The interest charge is generally 2 percent
or more above the prime rate.
Floating inventory liens are made by
lenders and secured by a claim on general
inventory consisting of a diversified and
low cost group of merchandise. Generally
less than 50 percent of the book value of
the average inventory is advanced. The
interest charge on a floating lien is typically
3 to 5 percent above the prime rate.
A warehouse receipt loan is an
arrangement whereby the lender receives
control of the pledged collateral. The
inventory may be retained by the borrower
in the firm’s warehouse with security
administered by a field warehousing
company. Or the inventory may be stored
in a terminal warehouse located in the
geographic vicinity of the borrower.
Generally, less than 75 to 90 percent of the
collateral’s value is advanced to the
borrower at an interest rate from 4 to 8
percent above the prime rate.