Tài chính doanh nghiệp - Chapter 16: Financing current assets

CHAPTER 16Financing Current AssetsWorking capital financing policiesA/P (trade credit)Commercial paperS-T bank loansWorking capital financing policiesModerate – Match the maturity of the assets with the maturity of the financing.Aggressive – Use short-term financing to finance permanent assets.Conservative – Use permanent capital for permanent assets and temporary assets.Moderate financing policyYearsLower dashed line would be more aggressive.$Perm C.A.Fixed AssetsTemp. C.A.S-TLoansL-T Fin:Stock,Bonds,Spon. C.L.Conservative financing policy$YearsPerm C.A.Fixed AssetsMarketable securitiesZero S-TDebtL-T Fin:Stock,Bonds,Spon. C.L.Short-term creditAny debt scheduled for repayment within one year.Major sources of short-term creditAccounts payable (trade credit)Bank loansCommercial loansAccrualsFrom the firm’s perspective, S-T credit is more risky than L-T debt.Always a required payment around the corner.May have trouble rolling over loans.Advantages and disadvantages of using short-term financingAdvantagesSpeedFlexibilityLower cost than long-term debtDisadvantagesFluctuating interest expenseFirm may be at risk of default as a result of temporary economic conditionsAccrued liabilitiesContinually recurring short-term liabilities, such as accrued wages or taxes.Is there a cost to accrued liabilities?They are free in the sense that no explicit interest is charged.However, firms have little control over the level of accrued liabilities.What is trade credit?Trade credit is credit furnished by a firm’s suppliers.Trade credit is often the largest source of short-term credit, especially for small firms.Spontaneous, easy to get, but cost can be high.The cost of trade creditA firm buys $3,000,000 net ($3,030,303 gross) on terms of 1/10, net 30.The firm can forego discounts and pay on Day 40, without penalty. Net daily purchases = $3,000,000 / 365 = $8,219.18Breaking down net and gross expendituresFirm buys goods worth $3,000,000. That’s the cash price.They must pay $30,303 more if they don’t take discounts.Think of the extra $30,303 as a financing cost similar to the interest on a loan.Want to compare that cost with the cost of a bank loan.Breaking down trade creditPayables level, if the firm takes discountsPayables = $8,219.18 (10) = $82,192Payables level, if the firm takes no discountsPayables = $8,219.18 (40) = $328,767Credit breakdown Total trade credit $328,767 Free trade credit - 82,192 Costly trade credit $246,575Nominal cost of costly trade creditThe firm loses 0.01($3,030,303) = $30,303 of discounts to obtain $246,575 in extra trade credit: kNOM = $30,303 / $246,575 = 0.1229 = 12.29%The $30,303 is paid throughout the year, so the effective cost of costly trade credit is higher.Nominal trade credit cost formulaEffective cost of trade creditPeriodic rate = 0.01 / 0.99 = 1.01%Periods/year = 365 / (40-10) = 12.1667Effective cost of trade credit EAR = (1 + periodic rate)n – 1 = (1.0101)12.1667 – 1 = 13.01%Commercial paper (CP)Short-term notes issued by large, strong companies. B&B couldn’t issue CP--it’s too small.CP trades in the market at rates just above T-bill rate.CP is bought with surplus cash by banks and other companies, then held as a marketable security for liquidity purposes.Bank loansThe firm can borrow $100,000 for 1 year at an 8% nominal rate.Interest may be set under one of the following scenarios:Simple annual interestDiscount interestDiscount interest with 10% compensating balanceInstallment loan, add-on, 12 monthsMust use the appropriate EARs to evaluate the alternative loan termsNominal (quoted) rate = 8% in all cases.We want to compare loan cost rates and choose lowest cost loan.We must make comparison on EAR = Equivalent (or Effective) Annual Rate basis.Simple annual interest“Simple interest” means no discount or add-on. Interest = 0.08($100,000) = $8,000 kNOM = EAR = $8,000 / $100,000 = 8.0%For a 1-year simple interest loan, kNOM = EARDiscount interestDeductible interest = 0.08 ($100,000) = $8,000Usable funds = $100,000 - $8,000 = $92,000INPUTSOUTPUTNI/YRPMTPVFV18.69570-10092Raising necessary funds with a discount interest loanUnder the current scenario, $100,000 is borrowed but $8,000 is forfeited because it is a discount interest loan.Only $92,000 is available to the firm.If $100,000 of funds are required, then the amount of the loan should be: Amt borrowed = Amt needed / (1 – discount) = $100,000 / 0.92 = $108,696Discount interest loan with a 10% compensating balanceInterest = 0.08 ($121,951) = $9,756Effective cost = $9,756 / $100,000 = 9.756%Add-on interest on a 12-month installment loanInterest = 0.08 ($100,000) = $8,000Face amount = $100,000 + $8,000 = $108,000Monthly payment = $108,000/12 = $9,000Avg loan outstanding = $100,000/2 = $50,000Approximate cost = $8,000/$50,000 = 16.0%To find the appropriate effective rate, recognize that the firm receives $100,000 and must make monthly payments of $9,000. This constitutes an annuity.Installment loanFrom the calculator output below, we have:kNOM = 12 (0.012043) = 0.1445 = 14.45%EAR = (1.012043)12 – 1 = 15.45%INPUTSOUTPUTNI/YRPMTPVFV121.2043-90100What is a secured loan?In a secured loan, the borrower pledges assets as collateral for the loan.For short-term loans, the most commonly pledged assets are receivables and inventories.Securities are great collateral, but generally not available.