56 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition
P15-10. Personal finance: Unsecured sources of short-term loans
LG 3; Challenge
a. Fixed-rate loan
b. Variable-rate loan
Time period First 60 days Days 61 to 90 Days 91 to 180
Prime rate 6.5% 7.0% 8.0%
P15-11. Effective annual rate
LG 3; Basic
Because this is a discount loan, interest is essentially paid up front. Given that the interest rate is 6%,
interest on the loan is $240,000, so we deduct that from the $4 million face value. In addition, we have to
P15-12. Compensating balances and effective annual rates
LG 3; Intermediate
a. Compensating balance requirement $800,000 borrowed 15%
(None of the $800,000 borrowed is required to satisfy the compensating balance requirement.)
d. The lowest effective interest rate occurs in situation (c), when Lincoln has $150,000 on deposit. In
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57 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition
P15-13. Compensating balance versus discount loan
LG 3; Intermediate
a. State Bank interest = $150,000 × 0.09 × 6/12 / ($150,000 – ($150,000 × 0.10))
b. If Weathers became a regular customer of State Bank and kept its normal deposits at the bank, then
P15-14. Integrative—comparison of loan terms
LG 3; Challenge
a. (0.08 0.033) 0.80 14.125%
b. Effective annual interest rate
[$2,000,000 (0.08 0.028) (0.005 $2,000,000)] 14.125%
($2,000,000 0.80)
´ + + ´ =
´
c. The revolving credit account seems better because the cost of the two arrangements is the same; with
a revolving loan arrangement, the loan is committed.
P15-15. Cost of commercial paper
LG 4; Intermediate
a.
$1,000,000 $978,000
Effective 90-day rate = 2.25%
$978,000
–=
b. Effective 90-day rate with transaction costs:
P15-16. Accounts receivable as collateral
LG 5; Intermediate
a. Acceptable accounts receivable
Customer Amount
D $ 8,000
E 50,000
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Chapter 15: Current Liabilities Management 58
b. Adjustments: 5% returns/allowances, 80% advance percentage.
Level of available funds [$200,000 (1 0.05)] 0.80 $152,000
P15-17. Accounts receivable as collateral
LG 5; Intermediate
a.
Customer Amount
A $20,000
P15-18. Accounts receivable as collateral, cost of borrowing
LG 3, 5; Challenge
a. [$134,000 ($134,000 0.10)] 0.85 $102,510
b. ($100,000 0.02) ($100,000 0.115) $2,000 $11,500 $13,500
$13,500
Interest cost 13.5% for 12 months
$100,000
= =
($100,000 0.02)
0.115
$100,000 2
æ ö
´
ç ÷
è ø
$2,000 $5,750 $7,750
$7,750
Interest cost 7.75% for 6 months
$100,000
= =
Effective annual rate (1 0.0775)21 16.1%
($100,000 0.02)
0.115
$100,000 4
æ ö
´
ç ÷
è ø
$2,000 $2,875 $4,875
Effective annual rate (1 0.0488)4 1 21.0%
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59 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition
P15-19. Factoring
LG 5; Intermediate
Holder Company
Factored Accounts
May 30
Accounts Amount Date Due
Status on
May 30
Amount
Remitted
Date of
Remittance
A $200,000 5/30 C 5/15 $196,000 5/15
B 90,000 5/30 U 88,200 5/30
The factor purchases all acceptable accounts receivable on a nonrecourse basis, so remittance is made on
uncollected as well as collected accounts.
P15-20. Inventory financing
LG 1, 6; Challenge
a. City-Wide Bank: [$75,000 (0.12 12)] (0.0025 $100,000) $1,000
b. City-Wide Bank is the best alternative because it has the lowest cost.
P15-21. Ethics problem
LG 2; Intermediate
The sales tax can be calculated based on the sales data, as follows:
An alternative method is to determine the taxable sales based on the sales tax reported.
These calculations show a discrepancy in the financial statement provided by Rancco. The company has
possibly underreported the amount of taxable income to the state and failed to pay the appropriate amount of
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Chapter 15: Current Liabilities Management 60
 Case
Case studies are available on www.myfinancelab.com.
Selecting Kanton Company’s Financing Strategy and Unsecured Short-Term
Borrowing Arrangement
This case asks the student to evaluate the permanent and short-term funding requirements of Kanton Company, and
to choose a financing strategy from among three alternatives: aggressive, conservative, and trade off. The
company’s funding requirements vary considerably during the year, showing a seasonal pattern and peaking
mid-year. Then the student must calculate the effective annual interest rates for two short-term borrowing
alternatives and make a recommendation.
a. Strategy I—Aggressive
Strategy 2—Conservative
Strategy 3—Tradeoff
1. Calculation of short-term requirements
Month
(1)
Total Funds
Requirements
(2)
Permanent
Requirements
Seasonal
Requirements
January $1,000,000 $3,000,000 $0
February 1,000,000 3,000,000 0
March 2,000,000 3,000,000 0
Monthly average: Permanent $3,000,000
b. Net working capital current assets current liabilities
c. The three strategies differ in terms of profitability and risk. The aggressive strategy is the most profitableit
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61 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition
on short-term financing, which may have more limited availability. Net working capital is lowest, also
increasing risk.
Because the conservative strategy funds the highest amount in any month for the whole year with
The tradeoff strategy falls between the two extremes in terms of both profitability and risk. The cost
($536,667) is higher than the aggressive strategy because the permanent funds requirement of $3,000,000 is
financed with more costly long-term funds. In five months (January, February, March, November, and
Mr. Mercado should consider implementing the tradeoff strategy. The wide swings in monthly funds
Note: Other recommendations are possible, depending on the student’s risk preference. Of course, the student
should present sound reasons for his or her choice of strategy.
d. 1. Effective interest, line of credit:
Chapter 15: Current Liabilities Management 62
Continuing the short-term focus of the previous chapter, the groups are asked to now look at the management of its
current liabilities. Students should make the connection between these short-term liabilities and sources of
short-term financing. Different accounts are developed that should allow the fictitious firm to maximize and
maintain profitability.
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