WORKING CAPITAL MANAGEMENT

WORKING CAPITAL MANAGEMENT - involves managing the firm's current assets and
liabilities to achieve a balance between profitability and risk that contributes positively to the firm's
value.

TRADE-OFF BETWEEN RISK and RETURNS

The management of net working capital requires consideration for the trade-off between
risk and returns. Holding more current than long-term assets means greater flexibility and reduced
liquidity risk. However, the rate of return will be less than with current assets than with long-term
assets. Long-term assets typically earn a greater return than current assets. Long-term financing
has less liquidity risk associated with it than short-term debt and it also carries a higher cost.

Consider the following:

Working Capital Policy
Conservative Aggressive
Level of Current Assets HIGH LOW
Reliance on Long-Term Financing HIGH LOW
Liquidity Risk LOW HIGH
Profitability and returns LOW HIGH

FACTORS TO CONSIDER IN MANAGING WORKING CAPITAL

APPROPRIATE LEVEL - This refers to adequacy of working capital

➢ Consider: Nature of business and length of operating cycle

STRUCTURAL HEALTH - This refers to composition of working capital

➢ Consider: Need for cash, accounts receivable and other current assets

LIQUIDITY - This refers to the relative transformation (and its rate) of current assets into more
liquid current assets (e.g., cash and marketable securities).

In general, sound working capital policy requires:

• Managing cash and its temporary investment efficiently. (Cash/Marketable Securities
Management)
• Ensuring efficient manufacturing operations and sound material procurement. (Inventory
Management)
• Drafting and implementing effective credit and collection policies. (Receivable
Management)
• Seeking favorable term from suppliers and other temporary creditors. (Short-Term Credit
Financing)
____________________________________________________________________________
EXERCISE: WORKING CAPITAL
Given the following information of Luffy Company:

Cash 15,000 Accounts Payable 10,000

Accounts Receivable 15,000 Current Tax Liability 3,000
Inventory 20,000 Accrued Payroll 7,000
Fixed Assets 50,000 Bonds Payable 80,000

REQUIRED: Determine the following:

1. Net Working Capital
2. Current Ratio
3. Acid-Test (Quick Assets) ratio

Page 1 of 10
 4. New Current Ratio (assuming the entire accounts payable are paid in cash)
5. New Current Ratio (assuming a 10,000 short term loan is obtained from a bank)

CASH & MARKETABLE SECURITIES (MS) MANAGEMENT

CASH MANAGEMENT - involves the maintenance of the appropriate level of cash to meet the
firm's cash requirements and to maximize income on idle funds.

MS MANAGEMENT - involves the process of planning and controlling investment in marketable

securities to meet the firm's cash requirements and to maximize income on idle funds.

OBJECTIVE : To minimize the amount of cash on hand while retaining sufficient liquidity to satisfy
business requirements (e.g., take advantage of cash discounts, maintain credit rating, meet
unexpected needs).

REASONS FOR HOLDING CASH: "Why would a firm hold cash when, being idle, it is a non-
earning asset?"

1. TRANSACTION motive (Liquidity motive) - Cash is held to facilitate normal transactions

of the business.
2. PRECAUTIONARY motive (Contingent motive) - Cash is held beyond the normal
operating requirement level to provide for buffer against contingencies, such as slow-down
in accounts receivable collection, possibilities of strikes, etc.
3. SPECULATIVE motive - Cash is held to avail of business incentives (e.g., discounts) and
investment opportunities.
4. CONTRACTUAL motive - Compensating Balance Requirements - A company is required
by a bank to maintain a certain compensating balance in its demand deposit account as
a condition of a loan extended to it.

OPTIMAL CASH BALANCE: BAUMOL MODEL

2 (𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡)(𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑇𝑟𝑎𝑛𝑠𝑐𝑎𝑡𝑖𝑜𝑛)

𝑂𝑝𝑡𝑖𝑚𝑎𝑙 𝐶𝑎𝑠ℎ 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 = √
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝐶𝑎𝑠ℎ

Total Costs of Cash Balance = Holding Costs + Transaction Costs

• HOLDING Costs = Average cash balance* x opportunity cost
• TRANSACTION Costs = Number of transactions** x Cost per transaction
* Average cash balance = OCB ÷ 2
** Number of transactions = Annual Cash Requirement ÷ OCB

CASH CONVERSION CYCLE - is the average length of time a peso is tied up in current assets.
It runs from the date the company makes payment of raw materials to the date company receives
cash inflows thru collection of accounts receivable. It is also known as the cash flow cycle.

Inventory conversion period (Average Age of Inventory) =Inventory / CGS* per day
+ Receivable collection period (Average Collection Period) =Receivables / Sales per day
- Payable deferral period (Average Payment Period) =Payables / Purchases per day
CASH CONVERSION CYCLE

*Alternatively, sales per day may be also used to compute conversion period. The intention is to
use an amount in proportion to unit sales.

The firm's goal should be to shorten its cash conversion cycle without hurting operations. The
longer the cash conversion cycle, the greater the need for external financing (hence, the more
cost of financing).

Page 2 of 10
CASH MANAGEMENT STRATEGIES
1. Accelerating collections (e.g., lockbox system)
2. Slowing disbursements (e.g., playing the floats)
3. Reducing precautionary idle cash (e.g., zero-balance accounts)

THE CONCEPT OF FLOAT

FLOAT - generally defined as the difference between the cash balance per BANK and the cash
balance per BOOK as of a particular period, primarily due to outstanding checks or other similar
reasons.

Types of Floats:
➢ POSITIVE (Disbursement) Float: Bank balance > Book balance
EXAMPLE: Outstanding checks issued by the firm that have not cleared yet.

➢ NEGATIVE (Collection) Float: Book balance > Bank balance

EXAMPLES:
1. MAIL Float - Amount of customers' payments that have been mailed by customers but not
yet received by the seller-company.
2. PROCESSING Float - Amount of customers' payments that have been received by the
seller but not yet deposited.
3. CLEARING Float - Amount of customers' checks that have been deposited but have not
cleared yet.

Good cash management suggests that positive float should be maximized (negative float
minimized),

MARKETABLE SECURITIES - Short-term money market instruments that can easily be

converted to cash.

➢ CERTIFICATES of DEPOSITS (CD) - savings deposits at financial institutions (e.g., time

deposit)

➢ MONEY MARKET FUNDS - shares in a fund that purchases higher-yielding bank CDs,
commercial paper, and other large-denomination, higher-yielding securities.

➢ GOVERNMENT SECURITIES
• Treasury bills - debt instruments representing obligations of the National
Government issued by the Central Bank and usually sold at a discount through
competitive bidding.
• CB Bills or Certificates of Indebtedness (CBCIs) - represent indebtedness by the
Central Bank.

➢ COMMERCIAL PAPERS - unsecured short-term promissory notes issued by corporations

with very high credit standing.

FACTORS INFLUENCING THE CHOICE OF MARKETABLE SECURITIES (MS)

1. RISK
• Default Risk - refers to the chances that the issuer may not be able to pay the interest
or principal on time or at all.
• Interest Rate Risk - refers to fluctuations in MS prices caused by changes in market
interest rates.
• Inflation Risk - refers to the risk that inflation will reduce the relevant value of the
investment.

Page 3 of 10
 2. RETURNS - The higher the MS's risk involved, the higher its required return. While MS
must consist of highly liquid short-term investments, the company should not sacrifice
safety for higher rates of return.
3. MATURITY - Maturity dates of MS held should coincide, whenever possible, with the date
at which the firm needs cash, or when the firm will no longer have cash to invest.
4. MARKETABILITY - refers to how quickly a security can be sold before maturity date
without a significant price concession.

EXERCISES: CASH & MS MANAGEMENT

1. OPTIMAL CASH BALANCE

Zorro Corporation is expecting to have total payments of P 1,800,000 for one year, cost per
transaction amounted to P 25, and the interest rate of marketable securities is 10%.

REQUIRED:
A. What is the company's optimal initial cash balance that minimizes total cost?
B. What is the total number of transactions (cash conversions) that will be required per year?
C. What will be the average cash balances for the period?
D. What is the total cost of maintaining cash balances?

(Adapted: Principles of Managerial Finance by Lawrence Gitman)

2. MINIMUM CASH BALANCE

Sanji Corporation's cost of goods sold per year is P 4,860,000. Annual operating expenses are
estimated at P 1,200,000, inclusive of depreciation and other non-cash expenses of P 300,000.

REQUIRED:
How much must the corporation's minimum cash balance be if it is to be equal to 15 days
requirement? (Use 360-day year)

(Adapted: Principles of Corporate Finance by Brealey, et.al.)

3. CASH CONVERGION CYCLE

Jinbei Corporation purchases merchandise on 20-day term. Goods are sold, on the average, 15
days after they are received. The average age of accounts receivable is 45 days. Jinbei pays its
payable on due date:

REQUIRED:
A. How long is the company's normal operating cycle?
B. How long is the company's cash conversion cycle?
C. What is the number of cash conversion cycles in one year (360 days)?

(Adapted: Theory and Practice in Financial Management by Brigham, et.al.)

4. FLOAT & LOCKBOX SYSTEM

It typically takes Robin Corporation 8 calendar days to receive and deposit customer remittances.
Robin is considering adopting a lockbox system and anticipates that the system will reduce the
float time to 5 days. Average daily cash receipts are P 220,000. The rate of return is 10 percent.

REQUIRED:
A. How much is the reduction of float in cash balances associated with implementing the
system?
B. What is the amount of return associated with the earlier receipt of the funds?
C. If the lockbox costs P 7,500 per month to implement, should the system be implemented?

a. Yes, savings is P 24,000 per year b. Yes, savings is P 82,500 per year.
c. No, loss is P 14,500 per year d. No, loss is P 24,000 per year.

(Adapted: Financial Management Principles and Applications by Keown, et.al.)

Page 4 of 10
5. MARKETABLE SECURITIES
Nami Corporation has P 20,000 excess cash that it might invest in marketable securities. It
considers investing the money for a holding period of 3 months. The transaction fee arising from
this is P 300.

REQUIRED: What is the break-even yield (annual basis) for the three-month holding period?

ACCOUNT RECEIVABLE (AR) MANAGEMENT

AR MANAGEMENT- involves the determination of the amount and terms of credit to extend to
customers and monitoring receivables from credit customers.

OBJECTIVE: To collect AR as quickly as possible without losing sales from high-pressure

collection techniques. Accomplishing this goal encompasses three topics: (1) credit selection and
standards, (2) credit terms, and (3) collection and monitoring program.

Consider this trade-off: Offering liberal and relaxed credit terms attracts more customers while it
would entail more costs of AR such as collection, bad debts and interests (opportunity costs).

FACTORS TO CONSIDER FOR AR POLICY

1. CREDIT STANDARD - Who (customers) will be granted credit? How much is the credit limit?
Factors to consider in establishing credit standards - the Five C's of Credit:

1. Character - customers' willingness to pay

2. Capacity - customers' ability to generate cash flows
3. Capital - customers' financial sources (I.e., net worth)
4. Conditions - current economic or business conditions
5. Collateral - customers' assets pledged to secure debt.

2. CREDIT TERMS - This defines the credit period and discount offered for customer's prompt
payment. The following costs associated with the credit terms must be considered: cash
discounts, credit analysis and collections costs, bad debt losses and financing costs.

3. COLLECTION PROGRAM - Shortening the average collection period may preclude too much
investment in receivable (low opportunity costs) and too much loss due to delinquency and
defaults. The same could also result to lass of customers if harshly implemented.
____________________________________________________________________________
EXERCISES: AR MANAGEMENT

1. AVERAGE INVESTMENT IN ACCOUNTS RECEIVABLE

Chopper Corporation sells on terms of 2/10, n/30. 70% of customers, normally avail of the
discounts. Annual sales are P 900,000, 80% of which is made on credit. Cost is approximately
75% of sales.

REQUIRED:
A. Average balance of accounts receivable.
B. Average investment in accounts receivable.

2. ACCELERATING COLLECTION
Brook Corporation makes credit sales of P 2,160,000 per annum. The average age of accounts
receivable is 30 days. Management considers shortening credit terms by 10 days. Cost of money
is 18%.

REQUIRED: How much will the company save from financing charges? (Assume 360-day year)

Page 5 of 10
3. DISCOUNT POLICY
Ussop Company presents the following information:

Annual credit sales: P 25,200,000

Rate of return: 18%
Collection period: 3 months
Terms: n/30

The company considers offering a 4/10, n/30 credit term. It expects 30% of its customers will take
advantage of the discount while sales would remain constant. The collection period is expected
to decrease to two months.

REQUIRED:

What is the net advantage (disadvantage) of implementing the proposed discount policy?

4. CREDIT POLICY - RELAXATION

The Franky Corporation reports the following information:

Selling price per unit P 10

Variable cost per unit P8
Total fixed costs P 120,000
Annual credit sales 240,000 units
Collection period 3 months
Rate of return 25%

The Franky Corporation, which has enough idle capacity, considers relaxing its credit standards
(i.e., more liberal extension of credit). The following is expected to result: sales will increase by
25%; collection period will increase to 4 months; bad debt losses are expected to be 5% on the
incremental sales; and collection costs will increase by P 40,000.

REQUIRED:

Should the proposed relaxation in credit standards be implemented?

a. Yes, savings is P 30,000 per year c. No, loss is P 14,500 per year
b. Yes, savings is P 50,000 per year d. No, loss is P 30,000 per year

INVENTORY MANAGEMENT

INVENTORY MANAGEMENT - refers to the process of formulation and administration of plans

and policies to efficiently and satisfactorily meet production and merchandising requirements and
minimize costs relative to inventories.

OBJECTIVE: To maintain inventory at a level that best balances the estimates of actual savings,
the cost of carrying additional inventory, and the efficiency of inventory control.

INVENTORY MANAGEMENT TECHNIQUES

➢ INVENTORY PLANNING - involves determination of the quality and quantity and location
of inventory, as well as the time of ordering, to minimize costs and meet future business
requirements.
Examples: Economic Order Quantity; Reorder Point; Just-in-Time (DIT) System

➢ INVENTORY CONTROL involves regulation of inventory within predetermined level:

adequate stocks should be able to meet business requirements, but the investment in
inventory should be at the minimum.

Page 6 of 10
SYSTEMS OF INVENTORY CONTROL

• JUST-IN-TIME PRODUCTION system - a "demand pull" (driven by demand) system in

which each component of a finished good is produced when needed by the next
production stage.
• FIXED ORDER QUANTITY system - an order for a fixed quantity is placed when the
inventory level reaches the reorder point. This is consistent with EOQ concept.

One of the most common techniques for determining the optimal order size for inventory
items is the EOQ model. The EOQ model considers various costs of inventory and then
determines what order size minimizes total inventory cost. The EOO assumes that the
relevant costs of inventory can be divided into order costs and carrying costs. Order costs
include the fixed clerical costs of placing and receiving orders. Carrying costs are the
variable costs per unit of holding an item of inventory for a specific period of time. The
EOQ model analyzes the tradeoff between order costs and carrying costs to determine
the order quantity that minimizes the total inventory cost.

The formulas for the EOQ model are as follows:

2 (𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑)(𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡)

𝐸𝑂𝑄 = √
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑
𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝑥 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
𝐸𝑂𝑄

𝐸𝑂𝑄
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝑥 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
2

Once the firm has determined its economic order quantity, its must determine when to
place an order. The reorder point reflects the firm's daily usage of the inventory item and
the number of days needed to place and receive an order.

Assuming that the inventory is used at a constant rate, the formula for the reorder point is:

𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑃𝑜𝑖𝑛𝑡 = (𝐷𝑎𝑦𝑠 𝑜𝑓 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑥 𝑑𝑎𝑖𝑙𝑦 𝑢𝑠𝑎𝑔𝑒) + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘

• MATERIALS REQUIREMENT PLANNING (MRP) - MRP is a push through system that is

designed to plan and control materials used in production based on a computerized
system that manufactures finished goods based on demand forecasts.
• MANUFACTURING RESOURCE PLANNING (MRP - II) - A closed loop system that
integrates various functional areas of a manufacturing company (e.g., inventories,
production, sales and cash flows). It is developed as an extension of MRP.
• ENTERPRISE RESOURCE PLANNING (ERP) - ERP integrates information systems of
all functional areas in a company. Every aspect of operations is interconnected as the
company is connected with its customers and suppliers.
• ABC Classification system - inventories are classified for selective control.
A items - high value requiring highest possible control
B items - medium cost items requiring normal control
C items - low-cost items requiring the simplest possible control

____________________________________________________________________________
EXERCISE: INVENTORY MANAGEMENT

Arlong Company has an a group inventory item that is vital to the production process. This item
costs P150 and Arlong uses 4000 units of the item per year. The cost per order is P150 per order
while the carrying cost per unit per year is P20. Arlong wants to determine its optimal order

Page 7 of 10
strategy for the item. Arlong operates 250 days per year. Its lead time is 2 days and Arlong wants
to maintain a safety stock of 4 units.

Required:
A. Compute for the Economic Order Quantity
B. Compute for the Ordering Cost
C. Compute for the Carrying Cost
D. Compute for the Reorder Point

SHORT-TERM CREDIT FINANCING

WORKING CAPITAL FINANCE - refers to optimal level, mix and use of current assets and
current liabilities.

WORKING CAPITAL FINANCING POLICIES

A. AGGRESSIVE FINANCING STRATEGY - operations are conducted with a minimum
amount of working capital. This is also known as restricted policy.
B. CONSERVATIVE FINANCING STRATEGY - a company seeks to minimize liquidity risk
by increasing working capital. This is also known as relaxed policy,
C. MODERATE FINANCING STRATEGY - also known as semi-aggressive or semi-
conservative financing strategy. Under this strategy, working capital maintained is
relatively not too high (conservative) nor too low (aggressive). This is also known as
balanced policy.
D. MATCHING POLICY - This is achieved by matching the maturity of financing source with
an asset's useful life. This is also known as self-liquidating policy or hedging policy.
• Short-term assets are financed with short-term liabilities.
• Long-term assets are funded by long-term financing sources.

HEDGING - Financing assets with liabilities of similar maturity.

FIXED AND LONG-

TERM ASSETS
PERMANENT
financing requirement
(Minimum operation
requirement)
TOTAL FINANCING PERMANENT
REQUIREMENT CURRENT ASSETS
TEMPORARY
financing requirement
(Seasonal operation
requirement)

____________________________________________________________________________
EXERCISE: FUNDING REQUIREMENTS
Roger Company holds, on average, P50,000 in cash and marketable securities, P1,250,000 in
inventory, and P750,000 in accounts receivable. Roger's business is stable over time, so its
operating assets can be viewed as permanent. In addition, Roger accounts payable of P425,000
are stable over time.

In contrast, Rayleigh Company, which produces bicycle pumps, has seasonal funding needs.
Rayleigh has seasonal sales, with its peak sales being driven by the summertime purchases of
bicycle pumps. Julien holds at minimum, P25,000 in cash and marketable securities, P100,000 in
inventory, and P60,000 in accounts receivable. At peak times, Julien's inventory increases to
P750,000 and its accounts receivable increases to P400,000. To capture production efficiencies,
Julien produces pumps at a constant rate throughout the year. Thus, accounts payable remain at
P50,000 throughout the year.

Page 8 of 10
REQUIRED:
1. Compute for Roger Company's permanent funding requirement.
2. Compute for Rayleigh Company's permanent funding requirement.
3. Compute for Rayleigh Company's peak seasonal funding requirement

FACTORS OF CONSIDERATIONS IN SELECTING SOURCES OF SHORT-TERM FUNDS

➢ COST: The effective costs of various credit sources.
➢ AVAILABILITY: The readiness of credit as to when needed and how much is needed.
➢ INFLUENCE: The influence of use of one credit source and availability of other sources
of financing.
➢ REQUIREMENT: The additional covenants unique to various sources of financing (e.9.,
loans)

SOURCES OF SHORT-TERM FUNDS

• UNSECURED CREDITS (Accruals, trade credit and commercial papers)

• SECURED LOANS (Receivable financing - pledging and factoring)
(Inventory financing - blanket lien, trust receipts, warehouse
receipts)
• BANKING CREDITS (Loan, line of credit, revolving credit agreement)

COSTS OF SHORT-TERM CREDIT

• Cost of TRADE CREDIT with supplier*:

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 360 𝑑𝑎𝑦𝑠

𝐶𝑜𝑠𝑡 = 𝑥
100% − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑

* This cost is caused by foregoing cash discounts (opportunity cost).

• Cost of BANK LOANS (EFFECTIVE ANNUAL RATE)

➢ Without compensating balance:

If not discounted (cash proceeds normally equal face value):

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐶𝑜𝑠𝑡 =
𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 (𝐹𝑎𝑐𝑒)

➢ If discounted (cash proceeds is net of interest - deducted in advance):

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐶𝑜𝑠𝑡 =
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡

➢ With compensating balance (CB):

If not discounted:

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 %
𝐶𝑜𝑠𝑡 = or 𝐶𝑜𝑠𝑡 =
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒−𝐶𝐵 100% −𝐶𝐵%

If discounted:

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 %
𝐶𝑜𝑠𝑡 = or 𝐶𝑜𝑠𝑡 =
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 −𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡− 𝐶𝐵 100% − 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 % − 𝐶𝐵%

Page 9 of 10
 • Cost of COMMERCIAL PAPERS

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝐼𝑠𝑠𝑢𝑒 𝐶𝑜𝑠𝑡 360 𝑑𝑎𝑦𝑠

𝐶𝑜𝑠𝑡 = 𝑥
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝐼𝑠𝑠𝑢𝑒 𝐶𝑜𝑠𝑡 𝑇𝑒𝑟𝑚
____________________________________________________________________________
EXERCISES: SHORT-TERM CREDIT FINANCING
1. COST OF TRADE CREDIT
Crocodile Trading Co. purchases merchandise for P 200,000, 2/10, n/30

REQUIRED:
A. The annual cost of trade credit.
B. The annual cost of trade credit If term is changed to 1/15, n/20

2. COST OF BANK LOANS

Vivy Trading Co. was granted a P 200,000 bank loan with 12% stated interest.

REQUIRED: The effective annual rate, under the following cases:

A. Vivy receives the entire amount of P 200,000.

B. Vivy was granted a discounted loan.
C. Vivy is required to maintain a compensating balance of P 10,000 under the non-discounted
loan.
D. Vivy is required to maintain a compensating balance of 10% under a discounted loan.

3. COST OF COMMERCIAL PAPER

Magellan Co. plans to sell P 100,000,000 in 180-day maturity paper, which it expects to pay
discounted interest at an annual rate of 12%. Due to this commercial paper, ABC expects to incur
P 100,000 in dealer placement fees and paper issuance costs.

REQUIRED: The effective cost of Magellan’s credit.

4. COST OF FACTORING RECEIVABLES

Vegapunk Co. has P 200,000 in receivable that carries 30-day credit term, 2% factor's fee, 6%
holdback reserve, and an interest of 12% per annum on advances.

REQUIRED: Determine the following:

A. Cash proceeds from factoring receivable.
B. The effective annual financing cost of factoring the receivable.

-END-

“A little progress each day adds up to big results”

-Satya Nani

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