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Assignment Question CH1

The document discusses various short-term financing scenarios faced by different companies, including payroll adjustments, payment terms for raw materials, loan alternatives, and factoring arrangements. It poses questions regarding the costs associated with these financial decisions, such as the implications of not taking discounts and the effective costs of different loan options. Additionally, it emphasizes the need for companies to evaluate both financial costs and other factors when choosing between financing methods.

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karishmapandey1030
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2 views

Assignment Question CH1

The document discusses various short-term financing scenarios faced by different companies, including payroll adjustments, payment terms for raw materials, loan alternatives, and factoring arrangements. It poses questions regarding the costs associated with these financial decisions, such as the implications of not taking discounts and the effective costs of different loan options. Additionally, it emphasizes the need for companies to evaluate both financial costs and other factors when choosing between financing methods.

Uploaded by

karishmapandey1030
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 1

Short Term Financing


1. Hetauda Shoe Company has monthly payroll of Rs 12,00,000. The company's labour union is
demanding that the company pay its workers weekly instead of a month. Currently payroll expense is
Rs 1,000 per pay day. The firm has a 10 percent opportunity cost. What is the annual cost of the union's
demand? [Assume 4 weeks in a month and 52 weeks in a year]
2. The Shikhar Company purchases raw materials on terms of "2/10, net 30". A review of the company's
records by the owner, Mr. Karki, revealed that payments are usually made 15 days after purchases are
received. When asked why the firm did not take advantage of its discounts, the bookkeeper, Mr. Thapa,
replied that it costs only 2 percent for these funds, whereas a bank loan would cost the firm 12 percent.
a. What mistakes is Mr. Thapa making?
b. What is the real cost of not taking advantage of the discount?
c. If invoice price is Rs 100,000, does invoice price affect annual percentage cost of not taking
discount?
d. If the firm could not borrow from the bank and were forced to resort to the use of trade credit
funds, what suggestion might be made to Mr. Thapa that would reduce the annual interest cost?
3. DC Company wishes to borrow Rs 200,000 for 6 months. It must choose one of the following
alternatives.
a. 10 percent loan on a collect basis, with face value due at end and 5% compensating
balance.
b. 9.5 percent loan on a discount basis, with face value due at the end, no compensating
balance.
c. 8 percent loan on a discount basis, with face value due at the end, with 20,0000
compensating balance..
d. 7 percent loan on an add-on basis to be paid in 6 equal installments
Which alternative you will choose to finance your requirement, if you decide based on cost of the
each alternative?
4. The Gorakhkali Tire Company intends to borrow Rs 500,000 to support its short-term financing
requirements during the next year. The company is evaluating its financing options at the bank where
it maintains its checking account. The financing alternative offered by the bank include:
Alternative 1:
A discount interest loan with a simple interest of 14 percent and no compensating balance
requirement.
Alternative 2:
A 12 percent simple interest loan that has a 15 percent compensating balance requirement.
Alternative 3:
A Rs 1 million revolving line of credit with simple interest of 12 percent paid on the amount borrowed
and a 1 percent commitment fee.
Required
a. Compute the effective cost (rate) of each financing alternative assuming Gorakhkali borrows Rs
500,000. Which alternative should Gandaki use?
b. For each alternative, how much would Gorakhkali have to borrow in order to have Rs 500,000
available for use (to pay the firm's bills)?

5. CM Trading Ltd needs an additional Rs 100,000. The financial manager is considering two
methods of obtaining this money: a loan from a commercial bank or a factoring arrangement. The
bank charges 12 percent per annum interest, discount basis. It also requires a 15 percent
compensating balance. The factor is willing to purchase Collins's accounts receivable and to
advance the invoice amount less a 3 percent factoring commission on the invoices purchased each
month. (All sales are on 30-day terms.) A 10 percent annual interest rate will be charged on the
total invoice price and deducted in advance. Also, under the factoring agreement, Collins can
eliminate its credit department and reduce credit expenses by Rs 2,000 per month. Bad debt
losses of 10 percent on the factored amount can also be avoided.
i. How much should the bank loan be in order to net Rs 100,000? How much accounts
receivable should be factored to net Rs 100,000?
ii. What are the computed interest rates and the annual total rupee costs, including credit
department expenses and bad debt losses, associated with each financing arrangement?
iii. Discuss some considerations other than cost that may influence management's choice
between factoring and a commercial bank loan.

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