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Chapter 17

Chapter 17. Sources of Short- and Intermediate-Term Funds. Accruals . Free source Limited ability to increase. Cost of a Loan Depends on. Funds you can use Length of time you may use the funds

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Chapter 17

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  1. Chapter 17 Sources of Short- and Intermediate-Term Funds

  2. Accruals • Free source • Limited ability to increase

  3. Cost of a Loan Depends on • Funds you can use • Length of time you may use the funds • A reduction in the amount of funds you may use or the time you may use the funds increases the cost

  4. Commercial Bank Loans • Line of credit • Revolving credit agreement • Permits borrower to draw on the loan as funds are needed • Prime rate

  5. Commercial Bank Loans • Factors that affect the cost • Origination fees • Fees on the unused balance • Discounted loan

  6. Trade Credit • Spontaneous source • Credit from suppliers • User obtains inventory • But now has an account payable • Examples of terms • n30 • 2/10, net 30

  7. Cost of Trade Credit • Depends on the term • The discount period • The pay period • Discount not taken (lost) should be viewed as the interest cost

  8. Cost of Trade Credit i = percentage discount 100%-percentage discount x 360 payment period - discount period

  9. Cost of Trade Credit • If terms are 2/10, net 30, the simple interest rate isi = 0.02 x 360 = 36.7% 1 - 0.02 30 - 10

  10. Cost of Trade Credit • If terms are 2/10, net 30, the compound interest rate is$98(1 + i)0.05479 = $100i = (1.0204)18.25 - 1 = 44.56%

  11. Cost of Trade Credit • Impact of • Riding the credit • Stretching the terms • Importance of the supplier's reaction

  12. Commercial Paper • Short-term promissory note • Issued by corporations • Sold at a discount • Issued in large denominations • Unsecured • Importance of high credit ratings

  13. Cost of Commercial Paper - Simple Rate: • i =__interest__ x _____12_____ proceeds used number of months paper is outstanding • $1,000,000 six month paper sold for $970,000 = $30,000 x 12 = 6.19% $970,000 6

  14. Cost of Commercial Paper - Compound Rate: • $970,000(1 + i)n/365 = $1,000,000 • $970,000(1 + i)180/365 = $1,000,000 • i = (1.03093)2.0278 - 1 = 6.37%

  15. Secured Loans • Possible collateral • Short-term securities • Accounts receivable • Inventory • Blanket liens • Warehouse financing

  16. Factoring • Selling accounts receivable • Cost of factoring depends on • The reserve • The discount or interest payment • The factor's commission

  17. Intermediate-Term Debt • 5 to 15 years term to maturity • Often referred to as "Notes" or ”Term loans“

  18. Intermediate-Term Debt • Notes sold to insurance companies and commercial banks • secured by equipment or property • similar to mortgage loans • periodic repayment of interest and principal

  19. Intermediate-Term Debt • Notes sold to individual investors • Unsecured • Non-callable • Often retired in one lump ("balloon") payment

  20. Leasing • An alternative to borrowing and owning • Lessor - the owner of the property or equipment • Lessee - the user of the property or equipment • Lease - the contractual agreement

  21. Leasing • Operating lease - contract for the use of equipment generally includes a service clause

  22. Capital or Financial Lease • Contract for expected life of the asset • No maintenance clause • Lease payment designed to earn a set return for the lessor

  23. Leasing • Sale and leaseback • Leveraged lease

  24. Decision to Lease • Depends on • Present value of the cash outflows associated with leasing compared to the • Present value of the cash outflows associated with borrowing and owning

  25. Decision to Lease • The importance of the salvage or residual value of the asset

  26. Accounting to Leases • Leasing as an example of "off balance sheet" financing • Leasing may understate the use of financial leverage

  27. Accounting to Leases • If the lease essentially provides the benefits of ownership, the lease must be "capitalized.“ • The value of the asset and the present value of the lease payments are put on the lessee's balance sheet.

  28. Bankruptcy • Insolvency and default may lead to bankruptcy • Bankruptcy - a court proceeding to liquidate or to reorganize the firm • Voluntary bankruptcy -protection from creditors • Involuntary bankruptcy

  29. The Order of Claims • Court costs • Unpaid labor expenses • Taxes • Secured creditors • Unsecured creditors • Preferred stock • Common stock

  30. Bankruptcy Proceedings • Courts favor reorganizations • Creditors consider the present value of possible future payments versus current payment of pennies on the dollar • Prepackaged bankruptcies

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