SHORT TERM FINANCING MANAGEMENT - KEY
1. What is the effective annualized cost of foregoing the trade discount on terms 2/10 net 80
10.64%
2. What is the effective annualized cost of foregoing the trade discount with terms 2/15 net 70
10.64%
Stanley Shoe Company established a line of credit with a local bank. The maximum
amount that can be borrowed under the terms of the agreement is P100,000 at an annual rate of
12%. A compensating balance averaging 10% of the amount borrowed is required. Prior to the
agreement, the company had no deposit with the bank. Shortly after signing the agreement, the
company needed P50,000 to pay off a note that was due. It borrowed the P50,000 from the bank
by drawing on the line of credit.
3. What is the effective annual cost of credit? 13.3%
Smith & Smith Enterprises has a line of credit with National Bank that allows the company
to borrow up to P350,000 at an interest rate of 15%. However, the firm must keep a compensating
balance of 10% of any amount borrowed on deposit at the bank. The company does not normally
keep a cash balance account with the bank.
4. What is the effective annual cost of credit? 16.67%
The Azurin Corporation was recently quoted terms on a commercial bank loan of 7%
discounted interest with a 20% compensating balance. The term of the loan is 1 year.
5. The effective cost of borrowing is 9.41%
Salguero, Inc. can issue 3-month commercial paper with a face value of P1,000,000 for
P980,000. Transaction costs will be P1,200.
6. The effective annualized percentage cost of the financing, based on a 360-day year, will be
8.95%
7. When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360day year, is: 36.7%
8. If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid
within 15 days (using a 360-day year), the approximate cost or benefit of the trade credit
terms is: 24%
9. Tolentino, Inc. buys on terms of 2/10, net 30 days. It does not take discounts, and it typically
pays 35 days after the invoice date. Net purchases amount to P720,000 per year. What is the
nominal annual cost of its non-free trade credit? 29.8%
10. Assume that the current borrowing rate is at 15%. Which of the following discounts should
the firm take?
a. 2/10, net/45 → cost of giving up 20.9%, thus, TAKE THE DISCOUNT.
b. 1/15, net/75 → cost of giving up 6.1%, thus, LET GO OF THE DISCOUNT.
c. 3/10, net/80 → cost of giving up 16.1%, thus, TAKE THE DISCOUNT.
d. 1/10, net/45 → cost of giving up 10.5%, thus, LET GO OF THE DISCOUNT.
Graveler Mining plans to borrow P100,000 for one year under a line of credit with a stated
interest rate of 7.5 percent and a 15 percent compensating balance.
Case A:
If the firm normally keeps a balance of about P10,000 in its checking account and is willing
to accept loan proceeds lesser than P100,000.
11. The loan proceeds would be P95,000
12. The interest to be repaid on the amount borrowed would be P7,500
13. The effective annual interest rate on the loan is 7.89%
Case B:
If the fi rm normally keeps almost no money in its checking account. Loan proceeds:
P100,000.
12. The interest to be repaid on the amount borrowed would be P8,823.53
13. The amount borrowed would be P117,647.06
A company obtained a short-term bank loan of P250,000 at an annual interest rate of 6%. As
a condition of the loan, the company is required to maintain a 20% compensating balance in its
checking account. Ordinarily, the company maintains a balance of P25,000 in its checking account
for transactions purposes.
14. What is the effective interest rate of the loan? 6.67%
Precious Company has a revolving line of credit of P300,000 with a one-year maturity. The
terms call for a 6% interest rate and a ½% commitment fee on the unused portion of the credit
line. The average loan balance during the year was P100,000.
15. How much is the annual cost (in pesos) of this financing arrangement? P7,000
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