Chapter 08: Sources of Short-Term Financing
8-10. Solution:
Talmud Book Company
Dollar cost of loan =
Days loan is outstanding
Amount borrowed Interest rate Days per year(360)
´ ´
60
$24,900 12% 360
1
$24,900 12% 6
$24,900 2.00% $498
= ´ ´
= ´ ´
= ´ =
11. Net credit position (LO1) McGriff Dog Food Company normally takes 27 days to pay for
average daily credit purchases of $9,530. Its average daily sales are $10,680, and it collects
accounts in 32 days.
a. What is its net credit position? That is, compute its accounts receivable and accounts
payable and subtract the latter from the former.
Accounts receivable = Average daily credit sales × Average collection period
Accounts payable = Average daily credit purchases × Average payment period
b. If the firm extends its average payment period from 27 days to 37 days (and all else
remains the same), what is the firm’s new net credit position? Has it improved its cash
flow?
8-11. Solution:
McGriff Dog Food Company
a. Net credit position = Accounts receivable – Accounts payable
Average daily Average
Accounts receivable = credit sales collection period
$341,760 $10,680 32days
´
= ´
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
Chapter 08: Sources of Short-Term Financing
Chapter 08: Sources of Short-Term Financing
Average daily Average
Accounts payable = credit purchases payment period
$257,310 $9,530 27
´
= ´
b. Accounts receivable will remain at $341,760
Accounts payable = $9,530 × 37 = 352,610
12. Compensating balances (LO2) Maxim Air Filters Inc. plans to borrow $300,000 for one
year. Northeast National Bank will lend the money at 10 percent interest and requires a
compensating balance of 20 percent. What is the effective rate of interest?
8-12. Solution:
Maxim Air Filters Inc.
Effective rate of interest with 20% compensating balance =
Interest rate 10% 10% 12.5%
1 C 1 .2 .8
or
Interest Days of the year (360)
Principal Compensating balance Days loan is outstanding
$30, 000 $30,000
1 1 12.5%
$300,000 $60,000 $240,000
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
Chapter 08: Sources of Short-Term Financing
13. Compensating balances (LO2) Digital Access Inc. needs $400,000 in funds for a project.
a. With a compensating balance requirement of 20 percent, how much will the firm need
to borrow?
b. Given your answer to part a and a stated interest rate of 9 percent on the total amount
borrowed, what is the effective rate on the $400,000 actually being used?
8-13. Solution:
Digital Access Inc.
a.
Amount needed
Amount to be borrowed = 1 C
$400, 000 $400,000
1 .20 .80
$500, 000
b.
$500,000 Total amount borrowed
9% Interest rate
$ 45,000 Interest
$45, 000 11.5%
$400,000
14. Compensating balances and installment loans (LO2) Carey Company is borrowing
$200,000 for one year at 12 percent from Second Intrastate Bank. The bank requires a 20 percent
compensating balance. What is the effective rate of interest? What would the effective rate be if
Carey were required to make 12 equal monthly payments to retire the loan? The principal, as
used in Formula 8–6, refers to funds the firm can effectively utilize (Amount borrowed –
Compensating balance).
8-14. Solution:
Carey Company
Effective rate of interest with 20% compensating balance =
Chapter 08: Sources of Short-Term Financing
Interest Days in the year (360)
Principal Compensating balance Days loan is outstanding
$24,000 360 $24,000 360 15%
$200,000 $40,000 360 $160,000 360
´
–
= ´ = ´ =
–
Installment loan with compensating balance
( )
( ) ( )
2 Annual no. payments Interest
Total no. of payments + 1 Principal
2 12 $24,000
12 1 $200,000 $40,000
$576,000 $576,000 27.69%
13 $160,000 $2,080,000
´ ´
´
´ ´
=+ ´ –
= = =
´
15. Compensating balances with idle cash balances (LO2) Randall Corporation plans to
borrow $233,000 for one year at 20 percent from the Waco State Bank. There is a 21
percent compensating balance requirement. Randall Corporation keeps minimum
transaction balances of $17,500 in the normal course of business. This idle cash counts
toward meeting the compensating balance requirement. What is the effective rate of
interest?
8-15. Solution:
Randall Corporation
Effective rate of interest =
Interest Days in the year (360)
Principal Compensating balance Days loan is outstanding
$46,600 360 $46,600 23.12%
$233, 000 $31, 430* 360 $201,570
´
–
´ ´ =
–
( )
* $48, 930 $17,500 $31, 430– =
Required compensating balance Minimum balance on
deposit Additional funds needed at bank
Chapter 08: Sources of Short-Term Financing
16. Compensating balances with idle cash balances (LO2) The treasurer for the Macon Blue
Sox baseball team is seeking a $23,600 loan for one year from the 4th National Bank of
Macon. The stated interest rate is 10 percent, and there is a 15 percent compensating
balance requirement. The treasurer always keeps a minimum of $2,280 in the baseball
team’s checking accounts. These funds count toward meeting any compensating balance
requirements. What will be the effective rate of interest on this loan?
8-16. Solution:
Macon Blue Sox Baseball Team
Effective rate of interest =
Interest Days in the year (360)
Principal Compensating balance Days loan is outstanding
$2,360 360 $2,360 10.56%
$23, 600 $1, 260 * 360 $22, 340
´
–
´ ´ =
–
( )
* $3,540 $2, 280 $1, 260– =
Required compensating balance  Minimum balance on
deposit Additional funds needed at bank
17. Effective rate under different terms (LO2) Your company plans to borrow $13 million
for 12 months, and your banker gives you a stated rate of 24 percent interest. You would
like to know the effective rate of interest for the following types of loans. (Each of the
following parts stands alone.)
a. Simple 24 percent interest with a 10 percent compensating balance.
b. Discounted interest.
c. An installment loan (12 payments).
d. Discounted interest with a 5 percent compensating balance.
8-17. Solution:
a. Simple interest with a 10% compensating balance
$3,120,000 $3,120,000
1 26.67%
$13,000,000 $1,300, 000 $11,700,000
´ = =
–
b. Discounted interest
Chapter 08: Sources of Short-Term Financing
$3,120,000 $3,120,000
1 31.58%
$13,000, 000 $3,120,000 $9,880,000
´ = =
–
c. An installment loan with 12 payments
2 12 $3,120, 000 $74,880,000 44.31%
13 $13, 000,000 $169,000,000
´ ´ = =
´
d. Discounted interest with a 5% compensating balance
( )
$3,120,000 / $13,000,000 – $3,120,000 – $650,000
$3,120,000/$9,230,000 = 33.80%
=
18. Effective rate under different terms (LO2) If you borrow $5,300 at $400 interest for
one year, what is your effective interest rate for the following payment plans?
a. Annual payment.
b. Semiannual payments.
c. Quarterly payments.
d. Monthly payments.
8-18. Solution:
a. $400/$5,300 = 7.55%
Chapter 08: Sources of Short-Term Financing
use in the business. This loan is for one year. What is the effective rate of interest? What
would the effective rate be if Zerox were required to make four quarterly payments to retire
the loan?
8.19. Solution:
Zerox Copying Company
Effective rates of interest with compensating balance
First determine interest
Chapter 08: Sources of Short-Term Financing
21. Cash discount under special circumstance (LO2) Mr. Hugh Warner is a very cautious
businessman. His supplier offers trade credit terms of 3/15, net 85. Mr. Warner never takes the
discount offered, but he pays his suppliers in 75 days rather than the 85 days allowed so he is
sure the payments are never late. What is Mr. Warner’s cost of not taking the cash discount?
8-21. Solution:
Hugh Warner
Discount % 360
Cost of not taking =
a cash discount 100% Disc.% Final duedate
Discount period
3% 360
100% 3% (75 15)
3.09% 6 18.54%
´
– –
= ´
– –
= ´ =
In this problem, Mr. Warner has the use of funds for 60 extra days
(75 – 15), instead of 70 extra days allowed by the credit terms (85
– 15). Mr. Warner’s suppliers are offering terms of 3/15, net 85.
Mr. Warner is effectively accepting terms of 3/15, net 75. If he
took the full 85 days to pay, his cost of not taking the discount
would be 15.89 percent.
22. Bank loan to take cash discount (LO1 and 2) The Reynolds Corporation buys from its
suppliers on terms of 3/17, net 45. Reynolds has not been utilizing the discounts offered
and has been taking 45 days to pay its bills.
Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to
take the discounts offered. Duke proposes that the company borrow from its bank at a
stated rate of 16 percent. The bank requires a 27 percent compensating balance on these
loans. Current account balances would not be available to meet any of this compensating
balance requirement.
Do you agree with Duke’s proposal?