SHORT TERM CREDIT FOR FINANCING CURRENT ASSETS Short-Term Funds -
Defined as those that are due and payable within a year.
Factors in selecting a source source of short-term short-term funds: 1. The The effe effect ctiv ivee cost cost of cre credi ditt 2. The availabili availability ty of credit credit in the amount amount needed needed and for the the period of time when when financing financing is required 3. The influence influence of the the use of a particul particular ar credit credit source source on the cost and and availabili availability ty of other other sources of financing 4. Any additional additional covenant covenantss of the loans loans that are are unique unique to the sources sources mentione mentioned d previously
Estimating Cost of Short-term Short-term credit credit 1. ost of trade redit
Nominal Annual Cost ( ANC )=
360 days Discount Period x 100 − Discount Period Period Days credit credit is outstanding outstanding − Discount Period
!llustrative "roblem# alculate the nominal annual cost of non$free trade credit under each of the following items# 1. 2%1&' n% n%(& 2. 1%1)' n% n%2& Answer#
1. 2.
ANC = ANC =
2 100 −2 1 100 −1
x x
360 60− 10 * 14.(+, 360 20−15
* -2.-,
3. ost of an/ 0oan a. b. c. d. e.
o
imple interest Discount !nterest Add$on !nterest imple !nterest with ompensating alances Discount !nterest with ompensating alances
imple !nterest → !n a single interest loan' the borrower receives the face value of the loan and repays the principal and interest at maturity date. ormula to compute the effective interest rate#
Interest Effectiveinterest rate simple = Face Value − Interest ample# ompute the effective annual rate for a one$year loan of "1&&'&&& at 12, annual interest per year payable at maturity.
Interest Effectiveinterest rate simple = Face Value − Interest
¿
Php. 12,000 Php . 100,000
¿ 12 5n a simple interest loan of 1 year or more' the nominal rate equals the effective rate. !f the loan had a term of less than a year' say +& days' the effective annual rate would be calculated as follows#
ff. annual 6ate 7simple8 *
( + )− 1 12
4 ( ) 1.03 −1 *
* 12.)(,
1
4
4
1
o
Discount !nterest → !n a discount interest loan' the ban/ deducts the interest in advance or discounts the loan. ormula to compute the effective annual rate is
Interest Amount Received
ff. Annual ratediscount * ample#
5n a one$year "hp 1&&'&&& loan with a 12, 7nominal8 rate' discount basis' the effective interest rate is#
Php 12,000 =13.64 Php 100,000 − Php 12,000 !f the discount loan is for a period of less than 1 year' say +& days' its effective annual interest rate is found as follows#
(
Effectiveannualrate = 1+
12,000 88,000
)− 4
1
¿ ( 1+ 0.136 )4 −1 ¿ 66.75 o
Add$5n !nterest → Add$on interest is interest that is calculated and added to funds received to determine the face amount of an installment loan# ormula 1.
( otal No. of Payments + 1 ) x Principal ¿ 2 x Annual No .of Payments x Interest Approximate annualrate add −on = ¿
2. The effective annual rate may be computed using the procedure in getting internal rate of return or effective yield. To illustrate# Determine the effective interest rate on a "hp1&&'&&& loan on a add$on basis at a nominal rate of 12, payable in 12 monthly installments. 1. The approimate annual interest rate is computed as follows#
¿
¿
2 x 12 x 12,000
( 12 + 1 ) x 100,000 288,000 1,300,000
¿ 22.15 2. ffective annual interest rate is obtained as follows#
!onthly payment =
100,000 +12,000 12
¿ 9,333.33 100,000 = 9,333.33 x F
F =10.71429 9sing the ": of an annuity of "1 table' n * 12' the effective interest rate will fall between 1 to 2 , per period. To compute for the eact rate' interpolation may be used#
(
Effective Interest Rate per Period = 1 +
¿1
(
0.54081 0.6798
x 1
11.2551 −10.71429 11.2551 −10.5753
)
¿ 1.795 12
Effective annualinterest rate =( 1 + 0.01795 ) −1
¿ 23.8 o
imple !nterest with ompensating alance
x 1
)
ompensating balance is the minimum account balance that a lending ban/ requires the borrower to maintain. !ts effect is to raise the effective rate on a loan because the net withdrawable amount is reduced.
Effectiveannualrate simple = C"
Interest Face Value−Compensating#alance
56 Nominalrate ( ) Effective annual rate simple = 1.0 −Compensating#alance ( ) C" To illustrate' assume that the ban/ offers to lend the co mpany "hp1&&'&&& for 1 year at a 12, simple rate but the company must maintain a compensating balance equal to 1&, of the loan amount. ;hat is the effective annual rate of the loan< The effective annual interest rate is computed as follows# Php 12,000 =13.33 Php 100,000 − Php 10,000 56 12 100 −10
o
=13.33
Discount interest with compensating balance The formula to compute for the effective annual rate if the loan is on a discount basis is# Interest Face value− Interest −Compensating#alance 56
Nominalrate () 1.0 − Nominal Interest Rate − Compensating#alance rate !llustration# Assume the same data as in number 4 ecept' that the loan is a discount loan. ;hat is the effective annual rate of the loan< The effective annual interest rate is computed as follows# Php . 12,000 =15.38 Php . 100,000 − Php 12,000 − Php . 10,000 56
12 100 −10 −12
= 15.38
ost of ommercial "aper To calculate the effective cost of credit' through the issuance of commercial paper' the following formula may be used#
Days 1
Effective annual rate discount =
Interest + Issue Costs x Face Value of the Notes− Interest − Issue Costs
¿ maturity 360 Days
¿
ample# The hoeneqc/ ompany uses commercial paper regularly to support its needs for short$term financing. The firm plans to sell "hp. 1&& =illion in 2-&$day$maturity paper on which it epects to have to pay discounted interest at an annual rate of 12 percent per annum. !n addition' hoeneqc/ epects to incur a cost of approimately "hp1&&'&&& in dealer placement fees and other epenses of issuing the paper. ;hat is the effective cost of credit of hoeneqc/< olution# The effective annual cost to hoeneqc/ can be calculated as follows# ¿
Php 9,000,000 + Php .100,000 1 Rate = x Php 100 !illion− Php 100,000 − Php . 9 !illion 270 360
¿ 13.35
¿ Interest = Php 100 !illion x 12 x ¿ Php 9 !illion
270 360
