Download Lesson 11 shorttermfinancing-planning

9
Foundations of Financial
Management
NINTH
th
EDITION
Sources of Short-Term
Financing
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Irwin/McGraw-Hill
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NINTH
9
Foundations of Financial
Management
th
EDITION
There are various sources of short-term
funds available to a firm:
T 6-1
– Trade Credit from Suppliers
– Bank Loans
– Corporate Promissory Notes
– Foreign Borrowing
– Loans Against Receivables and Inventory
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Hirt Irwin/McGraw-Hill
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NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-2
I. Trade Credit
The largest provider of short-term credit is in the
form of account payable.
Payment period
Trade credit is usually extended for 30 to 60 days.
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-3
I. Trade Credit
Cash discount policy
A cash discount allows a reduction in price if
payment is made within a specified time period.
Cost of failing
Discount %
360
= ------------------------ x ----------------------------------------to take discount 100%-Discount %
Final due date -Discount period
Ex: A 2 / 10, net 90 days
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Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-4
I. Trade Credit
Net Credit Position
- A firm’s Accounts Receivable (A/R) minus its
Accounts Payable (A/P)
- If A/R is greater than A/P, it is a net provider of
trade credit (positive number)
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NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-5
I. Trade Credit
- If A/P is greater than A/R, it is a net user of trade
credit (negative number)
- Larger firms tend to be net providers of trade
credit, while smaller firms are net users
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-6
I. Trade Credit
If a firm has average daily sales of $5,000 and
collects in 30 days, the accounts receivable balance
will be $150,000. If this is associated with average
purchases of $4,000 and a 25 days average payment
period, the average accounts payable balance is
$100,000. Indicating $50,000 more in credit is
extended than receivable.
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-7
II. Bank Credit
Prime Rate
- The interest rate charged to a bank’s best
customers
- Acts as a benchmark for calculating other
interest rates
The London Interbank Offer Rate (LIBOR)
U.S. dollar deposits is being used worldwide as a
base lending rate on dollar loans.
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-9
II. Bank Credit
Compensating Balance
- When a bank requires a minimum average
account balance in order to qualify for a loan
- Can be thought of as a form of collateral
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-10
II. Bank Credit
Ex: If you need $100,000 in funds, you must borrow
$125,000.
Amount to be borrowed = Amount needed / ( 1 - C )
= 100,000 / ( 1 - 0.2 )
= $125,000
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Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-11
II. Bank Credit
Effective Interest Rate
- The actual interest rate or “true” cost of a loan
- Also known as the annual percentage rate (APR)
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-12
II. Bank Credit
Ex: $60 interest on $1,000 loan for one year would
carry a 6 percent interest rate. What is effective rate
per year ?
ER = ( I / P ) x ( 360 / Days loan )
= ( 60 / 1,000 ) x ( 360 / 360 )
=6%
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-13
II. Bank Credit
Interest cost with discounted loan
- When a bank deducts the interest on the loan in
advance and lends the balance.
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-14
II. Bank Credit
Ex: a $1,000 one year loan with $60 of interest
deducted in advance.
ER = ( I / ( P – I )) x ( 360 / Days loan )
= (60 / ( 1,000 – 60 ) ) x ( 360 / 360 )
= 6.38%
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Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-15
II. Bank Credit
Interest costs with compensating balance
When a compensating balance is required as part
of the loan
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-16
II. Bank Credit
Ex: 6 percent is the state annual rate and 20 percent
compensating balance is required.
ER =
I
-------------1 - C
= 6 % / ( 1 – 20% )
= 7.5%
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-17
II. Bank Credit
Ex: We are paying $60 interest on a $1,000 loan, but
are able to use only $800 of the funds. The loan is
for a year.
ER =
I
------------P- C
x
360
--------------Days loan
= ( 60 / ( 1,000 – 200 )) x ( 360 / 360 )
= 7.5 %
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-18
II. Bank Credit
Interest cost on installment loan
- Calls for a series of equal payments over the life
of the loan
- ex., most car loans and home mortgages
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Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
Foundations of Financial
Management
th
EDITION
T 6-19
II. Bank Credit
Ex: you borrow $1,000 on a 12-month installment
basis and the interest requirement is $60.
2 x No of Payment x I
ER = ------------------------------------( No of Payment + 1 ) x P
= ( 2 x 12 x 60 ) / (( 12 + 1 ) x 1,000 )
= 11.08 %
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-20
II. Bank Credit
Commercial Paper:
- A short-term unsecured promissory note issued
to the public in minimum units of $25,000
- Total amount of commercial paper outstanding
has increased greatly in recent years
Block
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©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-21
II. Bank Credit
Eurodollar
- A U.S. dollar held or deposited in a foreign bank
- Loans from foreign banks denominated in
American dollars are called Eurodollar loans
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Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000
NINTH
9
th
EDITION
Foundations of Financial
Management
T 6-22
II. Bank Credit
A/R financing includes 2 choices
- Pledging accounts receivable as collateral for a
loan
- An outright sale (factoring) of receivables to a
bank or finance company
Block
Hirt Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc. 2000