CHAPTER 16 SHORT-TERM FINANCING I Questions Short-term debt financing refers to debt originally scheduled for repayment within one year Short-term financing may be either unsecured or secured Secured credit requires collateral whereas unsecured credit does not Short-term financing may be classified as spontaneous or negotiated Spontaneous sources arise from ordinary business transactions whereas negotiated sources require special effort Spontaneous sources include accounts payable and accruals Negotiated short-term credit consists of bank loans, commercial paper, accounts receivable loans, and inventory loans Trade credit is short-term credit extended by suppliers of goods and services Open accounts, notes payable, and trade acceptances are all types of credit but open accounts are the most widely used Unlike the other two types of shortterm trade credit, an open account is an informal arrangement Accruals are current liabilities for services rendered but for which payments have not been made Accruals include wages, taxes, rent, and interest payable and are spontaneous sources of short-term financing A line of credit is an informal borrowing agreement in which a bank agrees to extend credit up to a specific amount Commercial paper is a short-term obligation with maturities ranging from to 270 days issued by banks, corporations, and other borrowers to investors with temporarily idle funds Such instruments are unsecured and usually discounted II Practical Problems PROBLEM 1 ANC = 2% 100% – 2% = 14.69% x 360 60 – 10 16-2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations ANC = 1% 100% – 1% = 72.7% 360 20 – 15 x PROBLEM The effective annual cost to Pepcoke can be calculated as follows: P9,000,000* + P100,000 Rate = x P100 Million − P100,000 − P9 million = * Interest 270 360 13.35% = P100 Million x 12% x 270 360 = P9 million PROBLEM Effective rate = = P10,000 (0.10) P10,000 – P10,000 (0.10) P1,000 P9,000 = 11.1% Approximate effective rate = P1,000 / P5,000 = 20.0% Effective rate 10% – 0.15 – 0.10 = = 13.3% P10,000 – 0.15 – 0.10 = P13,333, since 0.15 (P13,333) = P2,000 is required for the compensating balance, and 0.10 (P13,333) = P1,333 is required for the immediate interest payment PROBLEM The effective rate is equal to net interest expense divided by proceeds received not proceeds borrowed Short-term Financing Interest Proceeds 120,000 – (0.06 x 100,000) 1,000,000 – 100,000 = = 16-3 12.67% PROBLEM The discounted interest cost of the commercial paper issue is calculated as follows: Interest expense = 0.10 x P200 million x 180 / 360 = P10 million The effective cost of credit can now be calculated as follows: P10 million + P125,000 RATE = P200 million – P125,000 – P10 million = x 180 / 360 10.66% PROBLEM Cost of not taking a cash discount = 2% 98% Discount % 100% – Disc % = x 360 (55 – 10) x 360 Final due date – Discount period = 2.04% x = 16.32% Effective rate of interest with a 20% compensating balance requirement: = = = Interest rate / (1 – C) 14% / (1 – 0.2) 14% / (0.8) = 17.5% The effective cost of the loan, 17.5%, is more than the cost of passing up the discount, 16.32% Kiwi Food Service, Inc should continue to pay in 55 days and pass up the discount PROBLEM Trust Bank Effective interest rate = x x P9,000 (P100,000 – P20,000 – P9,000) x (4 + 1) = P72,000 / P355,000 = 20.28% 16-4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Northeast Bank Effective interest rate = = x 12 x P9,000 (P100,000 – P10,000) x (12 + 1) P216,000 / P1,170,000 = 18.46% Choose Northeast Bank since it has the lowest effective interest rate The numerators stay the same as in part (a) but the denominator increases to reflect the use of more money because compensating balances are already maintained at both banks Trust Bank Effective interest rate = = P72,000 / (P100,000 – P9,000) x P72,000 / P455,000 = 15.82% = = P216,000 / (P100,000 x 13) P216,000 / P1,300,000 = 16.62% Northeast Bank Effective interest rate Yes If compensating balances are maintained at both banks in the normal course of business, then Trust Bank should be chosen over Northeast Bank The effective cost of its loan will be less  ... 20.28% 16- 4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Northeast Bank Effective interest rate = = x 12 x P9,000 (P100,000 – P10,000) x (12 + 1) P 216, 000 /.. .16- 2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations ANC = 1% 100% – 1% = 72.7% 360 20 – 15 x PROBLEM... – 0.10 = P13,333, since 0.15 (P13,333) = P2,000 is required for the compensating balance, and 0.10 (P13,333) = P1,333 is required for the immediate interest payment PROBLEM The effective rate