Fin 004 Midterm 1

R M
R T TE
SH O
R C E S F O R
SO U
F IN A N C I N G
R R E N T A SS E T
CU
FINANCIAL MANAGEMENT: SIR LINO MENDOZA

Learning objectives
 Understand the short term financing
concept
 Explain the factor of selecting a source of
short term funds
 estimating and calculation of short term
credit
Short term financing refers to debt originally scheduled
for repayment within one year. It is used to finance all part
of the firm’s working capital requirements and sometimes to
meet permanent financing needs.
Short term
financing
Spontaneous liabilities are financing that arises from the
normal course of business. These are the obligation of a
company that are accumulated automatically as a result of
the firm’s day to day business
The two major short term sources of such liabilities are
account payable and accruals.
Account payable
Accounts payable (AP), or "payables," refer to a company's short-
term obligations owed to its creditors or suppliers, which have not
yet been paid. Payables appear on a company's balance sheet as a
current liability.
Account payable
Account payable management is management by the firm of the
time that elapse between its purchases of raw materials and its
mailing payment to the suppliers.
There are three basic factors that should be considered in selecting
a source of short term financing
1. Effective cost of the credit source
2. Availability of credit
3. Effect of the use of a particular source of credit on the cost and
availability of other sources.
Estimating the annual
percentage
APR = x rate
Assume the following situation:
The effective interest rate on short term loans from bank A is 16 %
per year . Bank B claims that their interest rate is only 14.5 % per
year. However , Bank B charges interest on a discount basis.
Assume a loan amount of P100,000. how much is the annual interest
amount and percentage rate of the loan.
solutions
Bank A: Interest amount = P100,000 X 16 % X 1 YEAR = P16,000
APR = P16,000 / P100,000 X 1/1 = 16 %
Bank B: Interest amount = P 100,000 X 14.5% = P 14,500

APR = P14,500 / P 85, 500= 16.69%
APR = .145 / (1- .145) = 16.69 %
Estimating Cost of Short Term Credit
Accruals – are current liabilities for

services received but for which complete
payments have been made as of the reporting
date.
COST OF TRADE
CREDIT
Credit period during of trade credit during discount period sometime
called free trade credit.
 Implicit cost = supplier of trade credit should incurs the cost of
operating a credit department and financing account receivables.
 Opportunity cost /missed cash discount = trade credit does not
have explicit cost if there is no discount offered or if the buyer
pays the invoice during the discount period.
Nominal Annual Cost OR COST OF GIVING
UP A CASH DISCOUNT
X
Illustrative Problem 1
Broke industry , operator of small chain of video stores, purchased P1,000

worth of merchandise on February 27 from the suppliers extending terms
of 2/10 , net 30 EOM.
SOLUTION
Nominal Annual Cost OR COST OF GIVING
UP A CASH DISCOUNT
Illustrative Problem 2
Calculate the nominal annual cost of non- free trade
credit under each of the following terms.
1. 2/10, n/60
2. 2/10,n/ 30
Answer:
Credit term : 2/10, net 60 (ASSUME 360 DAYS )
ANC = X
= 14.69%
Credit term : 2/10, net 30
ANC = X
= 37.73%
APPROXIMATE COST OF GIVING UP AS CASH
DISCOUNT
app.cgcd = CD x
SOLUTION
Cost of Bank Loan
1. Simple interest in a single interest loan, the borrower receives the

face value of the loan and repay the principal and interest at maturity
date.
=
Example
Compute the effective annual interest rate for a one year loan of
P100,000 AT 12 % interest per year payable at maturity.
Discount interest
In a discount interest loan, the bank deduct the interest in
advance or discount the loan. Formula to compute the
effective annual rate is.
=
Example
On a 1 year P100,000 loan with a12% (nominal) rate
discount basis, the effective annual rate.
If the discount loan is for a period of less than 1 year , say 90
days , its effective annual interest rate is found as follow:
Add on interest
Add on interest is interest that is calculated and added to funds
received to determine the face amount of an installment loan.
2𝑥𝑎𝑛𝑛𝑢𝑎𝑙𝑁𝑜.𝑜𝑓𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑥𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
= (𝑡𝑜𝑡𝑎𝑙𝑁𝑜.𝑜𝑓𝑝𝑎𝑦𝑚𝑒𝑛𝑡+1) 𝑥 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙
The effective annual rate may be computed using the procedure in

getting internal rate of return or effective yield.
Determine the effective interest rate on a P100,000 loan on add- on basis at a
nominal rate of 12% payable in 12 monthly installments.
Simple interest with compensating balance
Compensating balance is the minimum account balance that a lending bank

require the borrower to maintain. It effect is to raise the effective rate on a
loan because the net withdrawable amount is reduced.
Effective annual rate =
Effective annual rate =

Simple interest with compensating balance
Assume that the bank offers to lend the company P

100,000 For 1 year at a 12 % simple rate but the company
must maintain the compensating balance equals to 10 % of
the loan amount. What is the annual rate of the loan
ANSWER:
Discount interest with compensating balance
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑓𝑎𝑐𝑒𝑣𝑎𝑙𝑢𝑒−𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡−𝑐𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑠𝑡𝑖𝑛𝑔𝑏𝑎𝑙𝑎𝑛𝑐𝑒
𝑛𝑜𝑚𝑖𝑛𝑎𝑙𝑟𝑎𝑡𝑒
1.0−𝑛𝑜𝑚𝑖𝑛𝑎𝑙𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡−𝑐𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑠𝑡𝑖𝑛𝑔𝑏𝑎𝑙𝑎𝑛𝑐𝑒𝑟𝑎𝑡𝑒
Discount interest with compensating balance
Assume that the bank offers to lend the company P 100,000

For 1 year at a 12 % simple rate but the company must
maintain the compensating balance equals to 10 % of the loan
amount. What is the annual rate of the loan
ANSWER:
Cost of commercial paper
1
x 𝑑𝑎𝑦𝑠𝑡𝑜𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
360𝑑𝑎𝑦𝑠
The Okada Company uses commercial paper regularly to support its need for
short term- financing . The firm plans to sell P100,000,000 in 270 days –
maturity paper on which it expects to have to pay discounted interest at an
annual rate of 12 percent per annum. In addition, Okada expects to incur a
cost approximately P100,000 in dealer placement fees and other expenses
of issuing the paper. What is the effective cost of credit of Okada.
Cost of commercial paper
ANSWER:
END OF MODULE
PREPARED By: Mr. LINO MENDOZA

Fin 004 Midterm 1

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R M

FINANCIAL MANAGEMENT: SIR LINO MENDOZA

Bank B: Interest amount = P 100,000 X 14.5% = P 14,500

Accruals – are current liabilities for

Broke industry , operator of small chain of video stores, purchased P1,000

1. Simple interest in a single interest loan, the borrower receives the

The effective annual rate may be computed using the procedure in

Compensating balance is the minimum account balance that a lending bank

Effective annual rate =

Effective annual rate =

Assume that the bank offers to lend the company P

Assume that the bank offers to lend the company P 100,000

PREPARED By: Mr. LINO MENDOZA

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