Exam 16: Managing Short-Term Liabilities Financing

Every 10 days you receive R5,000 worth of raw materials from your suppliers.The credit terms for these purchases are 3/20, net 30, and thus far you have been paying on the 30th day after each delivery because you are short of cash.You have been contemplating taking out a one-year bank loan for R4,850 (97 percent of the invoice amount).If the effective annual interest rate on this loan is 20 percent, what will be your net rand savings over the year by borrowing and then taking the discount? That is, what is the difference between the rands saved if you take the discount and the rands spent on interest expense for the loan?

Which of the following statements is correct?

Phillips Glass Company buys on terms of 2/15, net 30.It does not take discounts, and it typically pays 30 days after the invoice date.Net purchases amount to R720,000 per year.On average, how much "free" trade credit does Phillips receive during the year?

When a firm pledges its accounts receivable, if a customer that purchased goods from the firm does not pay, the selling firm must take the loss.

Which of the following statements is correct?

One of the advantages of short-term debt financing is that firms can expand or contract their short-term credit more easily than their long-term credit.

Assume a firm takes out a discounted loan with its local bank.By the very nature of a discount loan, a compensating balance requirement will exist, and this will lead to a higher effective rate on this loan versus the loan's simple, or stated, rate.

Accounts receivable financing, especially the factoring of accounts, is a very flexible source of funds.Once the factoring procedure has been established, funds from this type of financing will automatically increase as the firm increases its sales.

Which of the following statements is correct?

Wentworth Greenery harvests its crops four times annually and receives payment for its crop 90 days after it is picked and shipped.However, the firm must plant, irrigate, and harvest on a near continual schedule.The firm uses 90-day bank notes to finance its operations.The firm arranges an 11 percent discount interest loan with a 20 percent compensating balance four times annually.What is the effective annual rate of these discount loans?

C+ Notes' business is booming, and it needs to raise more capital.The company purchases supplies from a single supplier on terms of 1/10, net 20, and it currently takes the discount.One way of getting the needed funds would be to forgo the discount, and C+'s owner believes she could delay payment to 40 days without adverse effects.As an alternative, C+ could borrow from its bank at a rate of 12 percent, annual compounding, but with discount interest.Additionally, the bank would require a compensating balance of 20 percent of the loan amount.What is the difference between the EARs of the two financing sources?

The Lasser Company needs to finance an increase in its working capital for the coming year.Lasser is reviewing the following three options: (1) The firm can borrow from its bank on a simple interest basis for one year at 13 percent.(2) It can borrow on a 3-month, but renewable, loan at a 12 percent simple rate.The loan is a simple interest loan, completely paid off at the end of each quarter, then renewed for another quarter.(3) The firm can increase its accounts payable by not taking discounts.Lasser buys on credit terms of 1/30, net 60 days.What is the effective annual cost (not the approximate cost) of the least expensive type of credit, assuming 360 days per year?

A firm is said to be extending net trade credit when its accounts receivable are less than its accounts payable.

Which of the following aspects is not important to business when choosing a bank?

Judy's Fashions Inc.purchases supplies from a single supplier on terms of 1/10, net 20.Currently, Judy takes the discount, but she believes she could extend the payment to 40 days without any adverse effects if she decided not to take the discount.Judy needs an additional R50,000 to support an expansion of fixed assets.This amount could be raised by making greater use of trade credit or by arranging a bank loan.The banker has offered to loan the money at 12 percent discount interest.Additionally, the bank requires an average compensating balance of 20 percent of the loan amount.Judy already has a commercial checking account at this bank which could be counted toward the compensating balance, but the required compensating balance amount is twice the amount that Judy would otherwise keep in the account.Which of the following statements is most correct?

All else equal, a firm that purchases raw materials on credit will have an __________ in trade credit with a given __________ in purchases.

Financial managers should always use the free component of the trade credit, but they should use the costly component only after analysing this source of financing to make sure

Wicker Corporation is determining whether to support R100,000 of its permanent current assets with a bank note or a short-term bond.The firm's bank offers a two-year note where the firm will receive R100,000 and repay R118,810 at the end of two years.The firm has the option to renew the loan at market rates.As an alternative, the firm can sell its own 8.5 percent annual coupon bonds, with R1,000 face value and 2-year maturity, at a price of R973.97.Comparing the cost of the two alternatives, how many percentage points lower is the interest rate on the less expensive debt instrument?

A revolving credit agreement is a formal line of credit usually used by large firms.The firm will pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

When a firm has accounts payable that are greater than the level of its receivables, the firm is actually receiving net trade credit.