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FINANCING
Cash is collected and cash is disbursed
If the ending balance is positive then investment
opportunity arises
If the ending balance is negative then the deficit
need to be financed
Working capital policy of the firm need to be
reevaluated
Even the most efficient working capital policy
may have deficit.
FINANCING STRATEGY
Firms always have some or permanent amount
of inventory or receivable on book. They do turn
over. This minimum level of ongoing inventory
and receivable is referred to as Permanent
Current assets.
The temporary component of current assets
represents inventory that is accumulated in
anticipation of sales and the resulting A/C
receivable generated by increasing sales.
ALTERNATIVE FINANCING
STRATEGIES
Aggressive Financing Strategy
Conservative Strategy
Moderate strategy
AGGRESSIVE STRATEGY
Aggressive policy is basically a maturity
matching strategy.
Expected life of the assets is matched with the
expected life of the source of funds raised to
finance the assets.
Long term finance will be used to finance fixed
assets and permanent current assets and short
term finance to finance temporary current assets.
FINANCING STRATEGIES:
AGGRESSIVE
Short-Term Financing
$
Temporary Current Assets
Long-Term
Financing
Fixed Assets
Time
CONSERVATIVE POLICY
It
FINANCING
STRATEGIES:CONSERVATIVE
Excess Liquidity
$
Temporary Current Assets
Long-Term
Financing
Fixed Assets
Time
FINANCING STRATEGIES:
MODERATE
Excess
Liquidity
Short-Term
Financing
$
Temporary Current Assets
Long-Term
Financing
Fixed Assets
Time
TYPES OF CREDIT
DISCOUNT NOTE
Interest rate is fixed. Why??
- loan amount = $ 100000
- loan period = 60 days, rate 7 % annually
- Amount received from the Bank
= 100000 X [1- .07(60)/360]
= $ 98833.
Amount need to repaid at maturity = $ 100000
ADD ON NOTE
Interest
LINE OF CREDIT
A line of credit is a short term source of fund in
that it represents a fund that a bank stands
ready to lend a corporate client on demand at
anytime during a given period, generally a year.
Clean up feature
Compensating balance The firm cannot use the
full amount of loan.
PURPOSES
To meet seasonal short term need of the
borrower. What is clean up period?
Can be used as a backup to cover the maturing
commercial paper. What is back up line?
To work as liquidity cushion in case of
contingencies.
fee
- Price for the bank commitment to keep the
line available
- Amount may be on total credit line or unused
portion of credit line
- Most widely used for compensation
Compensating balances
- Need to keep a certain amount of deposit.
- Specified in dollar amount or as a percentage
of the lines.
LETTER OF CREDIT
BANKERS ACCEPTANCE
COMMERCIAL PAPER
Unsecured
promissory notes of an
organization issued for specific amount and a
fixed maturity.
Issued to the provider of fund.
It does not need to be registered with SEC if
its maturity is less than 270 days and it
fulfills one of the three conditions mentioned
below:
- Proceeds are used to finance current
transactions
- Notes are guaranteed by an bank
- Not offered to public
MATURITY: COMMERCIAL
PAPER & DENOMINATION
Most
UNSECURED BORROWING
Made on the basis of financial strength of the
borrower
Also referred to as Financial statement lending
In case of default the Bank becomes general
creditor
Usually granted to firms having long stable
history of strong financial performance
SECURED BORROWING
Gives the lender to right to claim a specific asset
in case of default by the borrower
It can be a collateralized loan or an asset based
loan.
COLLATERALIZED LOAN
Collateral must be adequate to cover the loan
but the Bank does not view it as a means of
repaying the loan
A/C receivable may loose value when the bank
wants to collect it later
Inventory may fail to obtain its full value when
it is sold
Raw materials Commodity value
WIP Very little value
Finished goods may have reasonable value
Difficulty in generating cash flows arises
because sales are below projections Obtaining
full value for inventory is rare occurrence.
FACTORING
Sale
INVENTORY FINANCING
Floating Lien- Borrower pledges its inventories
without particular specification. Relatively small
fraction of total value of inventory is pledged
Trust Receipt- Lender has a direct lien on a
specific inventory item. Suitable for relatively
expensive and low turnover item
CHAPTER 16 PROBLEM 4
Ralph,
CHAPTER 16 PROBLEM 4
a.
b.
CHAPTER 16 PROBLEM 4
M&M Products, Inc. - estimating the cost of
commercial paper.
ASSUMPTIONS:
Face amount =
$12,000,000
Discount rate =
9.00%
Maturity (days) = 30
Dealer annual fee= 0.20%
Commitment fee = 0.50%
CHAPTER 16 PROBLEM 4
a.)
Assume this is the only commercial paper
issue planned for the year.
Issue price =
Face - (Discount rate *
(Days/360) * Face Amount)
Interest paid =
Face - Issue price
Interest paid =
$90,000
CHAPTER 16 PROBLEM 4
Commitment
fee =
Face * (Commitment
fee * (360/360))
Commitment fee =
$60,000
(Assuming only CP issue this year.)
Dealer fee =
Face * rate * (30/360)
Dealer fee =
$2,000
CHAPTER 16 PROBLEM 4
$152,000
Usable Funds =
Usable funds =
$11,910,000
Effective rate =
(Out of pocket cost /
Usable funds) * (365/Days)
Effective rate =
15.53%