Documente Academic
Documente Profesional
Documente Cultură
Finance
-1
Finance
ALTERNATIVE CURRENT ASSET ALTERNATIVE CURRENT ASSET FINANCING POLICIES FINANCING POLICIES
Finance
-2
ALTERNATIVE CURRENT ASSET FINANCING ALTERNATIVE CURRENT ASSET FINANCING POLICIES POLICIES Most businesses experience seasonal and/or cyclical fluctuations. For example,construction firms have peaks in the spring and summer, retailers peak around Christmas, and the manufacturers who supply both construction companies and retailers follow similar patterns. Similarly, virtually all businesses must build up current assets when the economy is strong, but they then sell off inventories and reduce receivables when the economy slacks off. Still, current assets rarely drop to zerocompanies have some permanent current assets, which are the current assets on hand at the low point of the cycle.
Finance
ALTERNATIVE CURRENT ASSET FINANCING ALTERNATIVE CURRENT ASSET FINANCING POLICIES POLICIES
Then, as sales increase during the upswing, current assets must be increased, and these additional current assets are defined as temporary current assets. The manner in which the permanent and temporary current assets are financed is called the firms current asset financing policy.
Finance
-3
LINKS BETWEEN LONG-TERM AND LINKS BETWEEN LONG-TERM AND SHORT-TERM FINANCING DECISIONS SHORT-TERM FINANCING DECISIONS
Finance
What is the best level of long-term financing relative What is the best level of long-term financing relative to the cumulative capital requirement? to the cumulative capital requirement?
It is hard to say. There is no convincing theoretical analysis of this question. We can make practical observations, however. First, most financial managers attempt to match maturities of assets and liabilities.
That is, they finance long-lived assets like plant and machinery with long-term borrowing and equity.
Second, most firms make a permanent investment in net working capital (current assets less current liabilities). This investment is financed from long-term sources.
Finance
-4
The maturity matching, or self--liquidating, The maturity matching, or self-liquidating, self-liquidating, self liquidating, approach approach The maturity matching, or self-liquidating, approach calls for matching asset and liability maturities as shown in Panel a of Figure 15-3. This strategy minimizes the risk that the firm will be unable to pay off its maturing obligations. A financing policy that matches asset and liability maturities. This is a moderate policy. Actually, of course, two factors prevent this exact maturity matching:
(1) there is uncertainty about the lives of assets, and (2) some common equity must be used, and common equity has no maturity.
Finance
10
The maturity matching, or self--liquidating, The maturity matching, or self-liquidating, self-liquidating, self liquidating, approach approach
Finance
-5
11
Panel b of Figure 15-3 illustrates the situation for a relatively aggressive firm
that finances all of its fixed assets with long-term capital and part of its permanent current assets with short-term, nonspontaneous credit. Note that we used the term relatively in the title for Panel b because there can be different degrees of aggressiveness.
However, short-term debt is often cheaper than long-term debt, and some firms are willing to sacrifice safety for the chance of higher profits.
Finance
12
For example, the dashed line in Panel b could have been drawn below the line designating fixed assets, indicating that all of the permanent current assets and part of the fixed assets were financed with short-term credit; this would be a highly aggressive, extremely non conservative position, and the firm would be very much subject to dangers from rising interest rates as well as to loan renewal problems.
Finance
-6
13
Panel c of Figure 15-3 has the dashed line above the line designating permanent current assets, indicating that permanent capital is being used to finance all permanent asset requirements and also to meet some of the seasonal needs. In this situation, the firm uses a small amount of short-term, nonspontaneous credit to meet its peak requirements, but it also meets a part of its seasonal needs by storing liquidity in the form of marketable securities.
Finance
14
The humps above the dashed line represent short-term financing, while the troughs below the dashed line represent short-term security holdings.
Panel c represents a very safe, conservative current asset financing policy.
where long-term financing covers more than the total asset requirement, even at seasonal peaks. The firm will have excess cash available for investment in marketable securities when the total asset requirement falls from peaks.
Because this approach implies chronic short-term cash surpluses and a large investment in net working capital, it is considered a flexible strategy.
Finance
-7
15
Finance
16
Several considerations must be included in a proper analysis Several considerations must be included in a proper analysis
Maturity Hedging. Most firms finance inventories with short-term bank loans and fixed assets with long-term financing. Firms tend to avoid financing long-lived assets with short-term borrowing. This type of maturity mismatching would necessitate frequent financing and is inherently risky, because short-term interest rates are more volatile than longer rates. Term Structure. Short-term interest rates are normally lower than long-term interest rates. This implies that, on average, it is more costly to rely on long-term borrowing than on short-term borrowing.
Finance
-8
17
ADVANTAGES AND DISADVANTAGES OF ADVANTAGES AND DISADVANTAGES OF SHORT- TERM FINANCING SHORT--TERM FINANCING SHORTSHORT
Although short-term credit is generally riskier than long-term credit, using short-term funds does have some significant advantages
Finance
18
Finance
-9
19
20
RISKS OF LONG--TERM VERSUS SHORT--TERM DEBT LONGSHORTRISKS OF LONG- TERM VERSUS SHORT- TERM DEBT LONG SHORT
Even though short-term rates are often lower than longterm rates, and is more readily available than long-term credit. short-term credit is riskier for two reasons: (1) If a firm borrows on a long-term basis, its interest costs will be relatively stable over time, but if it uses short-term credit, its interest expense will fluctuate widely, at times going quite high. (2) If a firm borrows heavily on a short-term basis, a temporary recession may render it unable to repay this debt. If the borrower is in a weak financial position, the lender may not extend the loan, which could force the firm into bankruptcy.
Finance
- 10
21
Finance
22
Major types of Short-Term Funds ShortMajor types of Short- Term Funds ShortAccruals, Accounts payable (trade credit), Bank loans, and Commercial paper.
Finance
- 11
23
Accruals Accruals
Firms generally pay employees on a weekly, biweekly, or monthly basis, so the balance sheet will typically show some accrued wages. Similarly, the firms own estimated income taxes, Social Security and income taxes withheld from employee payrolls, and sales taxes collected are generally paid on a weekly, monthly, or quarterly basis, hence the balance sheet will typically show some accrued taxes along with accrued wages.
Finance
24
Accruals Accruals
These accruals increase automatically, or spontaneously, as a firms operations expand. Further, this type of debt is free in the sense that no explicit interest is paid on funds raised through accruals. However, a firm cannot ordinarily control its accruals: The timing of wage payments is set by economic forces and industry custom, while tax payment dates are established by law. Thus, firms use all the accruals they can, but they have little control over the levels of these accounts.
Finance
- 12
25
Finance
26
Commercial banks, whose loans generally appear on balance sheets as notes payable, are second in importance to trade credit as a source of short-term financing for nonfinancial corporations. The banks influence is actually greater than it appears from the dollar amounts because banks provide nonspontaneous funds. As a firms financing needs increase, it requests additional funds from its bank. If the request is denied, the firm may be forced to abandon attractive growth opportunities.
Finance
- 13
27
Finance
28
Maturity Maturity
Although banks do make longer-term loans, the bulk of their lending is on a shortterm basis about two-thirds of all bank loans mature in a year or less. Bank loans to businesses are frequently written as 90-day notes, so the loan must be repaid or renewed at the end of 90 days. Of course, if a borrowers financial position has deteriorated, the bank may refuse to renew the loan. This can mean serious trouble for the borrower.
Finance
- 14
29
4) any collateral that might have to be put up as security for the 5) any other terms and conditions to which the bank and the
borrower have agreed. When the note is signed, the bank credits the borrowers checking account with the funds, so on the borrowers balance sheet both cash and notes payable increase.
Finance
30
- 15
31
Finance
32
- 16
33
34
- 17
35
Finance
36
Revolving Credit Vs. Line of Credit Revolving Credit Vs. Line of Credit
Note that a revolving credit agreement is very similar to an informal line of credit, but with an important difference:
The bank has a legal obligation to honor a revolving credit agreement, and it receives a commitment fee. Neither the legal obligation nor the fee exists under the informal line of credit.
Finance
- 18
37
Revolving Credit Vs. Line of Credit Revolving Credit Vs. Line of Credit
Often a line of credit will have a clean-up clause that requires the borrower to reduce the loan balance to zero at least once a year. Keep in mind that a line of credit typically is designed to help finance negative operating cash flows that are incurred as a natural part of a companys business cycle, not as a source of permanent capital.
Finance
38
Example Example
The red company has a revolving line of credit of $300,000 with a one-year maturity . The terms call for a 6% interest rate and a % commitment fee on the unused portion of the line of credit . The average loan balance during the year was $100,000. We can calculate the annual cost of this financing arrangement as follow :
Finance
- 19
39
The annual cost of this financing arrangement The annual cost of this financing arrangement
interest rate X Borrowed amount + limit(Credit line limit- Borrowed amount) X commitment fee
(6%X$100000)+[(300000(6%X$100000)+[(300000-100000)x1/2%]=$7000
Finance
40
The prime interest rate is the rate charged by commercial banks to their best (the largest and financially strongest) business customers. It is traditionally the lowest rate charged by banks. However, in recent years, banks have been making loans at still lower rates in response to competition from the commercial paper market.
Finance
- 20
The cost of a bank loan is calculated based on its The cost of a bank loan is calculated based on its terms terms
41
Finance
42
For example, if the bank quotes an annual rate of 12 percent on a simple interest loan of $100,000 for 1 month, then at the end of the month you would need to repay $100,000 plus 1 months interest. This interest is calculated as
Your total payment at the end of the month would be Repayment of face value plus interest = $100,000 + $1,000 = $101,000
Finance
- 21
43
44
Finance
- 22
45
Finance
46
Discounted Interest with a compensating balance requirement Discounted Interest with a compensating balance requirement
Assume the same loan as in the previous example, but there is also a 10% compensating balance requirement. In this case, the effective rate of interest to be paid on the loan will be 9.8% ($800 / $8,200). This is because the company is essentially receiving only $8,200, because of the $800 of discounted interest and the $1,000 compensating balance! but they have to pay interest as if they had received all $10,000. Or, .08/(1-.08-.1)=9.8%.
Finance
- 23
47
At the end of the month you repay the bank the $100,000 face value of the loan, so you are effectively paying interest of $1,000 on a loan of $99,000.
Finance
48
MCQ MCQ
The Oxford Corporation was recently quoted terms on 7% discounted interest with a 20% compensating balance. The term of the loan is 1 year .The effective cost of borrowing is (rounded ) . 8.75%. 9.41%. 7.53%. 9.59%.
A. B. C. D.
= 0.07/(1-0.07-0.20)
Finance
- 24
49
MCQ MCQ
A company has a temporary need for funds. Management is trying to decide between not taking cash discounts from one of its three biggest suppliers, or a 14.75% per annum renewable discount loan from its bank for three months. The suppliers' terms are as follows: Fort Co, 1/10, net 30 Riley Manufacturing Co. 2/15, net 60 Shad, Inc. 3/15, net 90 Using a 360-day year, the cheapest source of short-term financing in this situation is: A. The bank. B. Fort Co, C. Riley Manufacturing Co. D. Shad, Inc 14.75%/(1-14.75%)=17.30,1/99*360/20=18.18%,2/98*360/45=16.32%, /97*360/75=14.84%
Finance
50
MCQ MCQ
Morton Company needs to pay a supplier's invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance , Question1: The amount Morton Company must borrow to pay the supplier within the discount period and cover the compensating balance is: A. $55,000. B. $55,056. C. $55,556. D. $54,444.
If the invoice is paid within the discount period , the company will pay 50000$*.98=49000$ ,so by requiring a compensating balance of 10% the company must borrow L which equals 49000+0.10L , then L=54 444$ . Or the amount of 49000$ should represent 90% of the loan , so the loan is 49000$*100/90 = 54 444$
Finance
- 25
51
MCQ MCQ
Morton Company needs to pay a supplier's invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance Question2: Assuming Morton Company borrows the money on the last day of the discount period and repays it 30 days later, the effective interest rate on the loan is: A. 12.00%. B. 13.33%. C. 13.20%. D. 13.48%. 12%/(1-10%)= 13.33%
Finance
52
That s it .
Finance
- 26
53
Commercial Paper Commercial Paper Unsecured, short-term promissory notes of large firms, usually issued in denominations of $100,000 or more and having an interest rate somewhat below the prime rate. The interest rate on commercial paper fluctuates with supply and demand conditionsit is determined in the marketplace, varying daily as conditions change.
Finance
54
Commercial Paper Commercial Paper On the other hand, using commercial paper permits a corporation to tap a wide range of credit sources, including financial institutions outside its own area and industrial corporations across the country, and this can reduce interest costs.
Finance
- 27
55
Finance
56
- 28
57
Finance
58
Finance
- 29
59
60
Finance
- 30
61
Trust Receipt.
Under this arrangement, the borrower holds the inventory in trust for the lender. The document acknowledging the loan is called the trust receipt. Proceeds from the sale of inventory are remitted immediately to the lender.
Finance
62
A third party, such as a public warehouse, holds the collateral and serves as the creditors agent, and the creditor receives the terminal warehouse receipts evidencing its rights in the collateral.
Finance
- 31
63
Finance
64
- 32
65
Once the firm has sold its receivables, the factor bears all the responsibility for collecting on the accounts.
Therefore, the factor plays three roles:
it administers collection of receivables, takes responsibility for bad debts assumes the full risk of default , and provides finance.
Finance
66
Finance
- 33
67
The formula to calculate the cash received from factoring is as The formula to calculate the cash received from factoring is as follows: follows: Face amount of the receivables . Minus :The amount of the reserve (calculated from the face amount of receivables if applicable) . Minus :The factor's fee (this is also calculated from the face amount) = Amount that the seller needs to pay interest on Minus :Interest for the time period before the collection of the receivables .
Finance
68
Example Example
Assume a factor charges a 4% fee and 12% interest on all monies that are advanced to the seller. Additionally, the factor reserves a 7% reserve. The amount of the receivables to be sold is $150,000 and it is due for collection in 120 days. The amount of cash that will be received by the seller is calculated as follows: Amount of receivables submitted $150,000 Minus: 7% reserve ( % of face ) (10,500) Minus: 4% factor's fee ( % of Face ) (6,000) Amount accruing to the company $133,500 Minus: 12% interest for 120 days (on $133,500) (5,340) Amount to be received immediately 128.160
Finance
- 34