Working Capital

Answer exercise questions.

15-2. (Estimating the cost of commercial paper) On February 3, 2003, the Burlington Western Company plans a commercial paper issue of $20 million. The firm has never used commercial paper before but has been assured by the firm placing the issue that it will have no difficulty raising the funds. The commercial paper will carry a 270-day maturity and require interest based on a rate of 11 percent per annum. In addition, the firm will have to pay fees totaling $200,000 to bring the issue to market and place it. What is the effective cost of the commercial paper to Burlington Western?

15-3. (Cost of trade credit) Calculate the effective cost of the following trade credit terms when payment is made on the net due date.
a. 2/10, net 30
b. 3/15, net 30
c. 3/15, net 45
d. 2/15, net 60

15-4. (Annual percentage yield) Compute the cost of the trade credit terms in problem 15-3 using the compounding formula, or annual percentage yield.

15-10. (Cost of secured short-term credit) The Sean-Janeow Import Co. needs $500,000 for the 3-month period ending September 30, 2008. The firm has explored two possible sources of credit.

1. S-J has arranged with its bank for a $500,000 loan secured by its accounts receivable. The bank has agreed to advance S-J 80 percent of the value of its pledged receivables at a rate of 11 percent plus a 1 percent fee based on all receivables pledged. S-J’s receivables average a total of $1 million year-round.

2. An insurance company has agreed to lend the $500,000 at a rate of 9 percent per annum, using a loan secured by S-J’s inventory of salad oil. A field warehouse agreement would be used, which would cost S-J $2,000 a month. Which source of credit should S-J select? Explain.

15-12. (Cost of factoring) A factor has agreed to lend JVC Corporation working capital on the following terms: JVC’s receivables average $100,000 per month and have a 90-day average collection period. (Note that JVC’s credit terms call for payment in 90 days, and accounts receivable average $300,000 because of the 90-day average collection period.) The factor will charge 12 percent interest on any advance (1 percent per month paid in advance) and a 2 percent processing fee on all receivables factored and will maintain a 20 percent reserve. If JVC undertakes the loan, it will reduce its own credit department expenses by $2,000 per month. What is the annual effective rate of interest to JVC on the factoring arrangement? Assume that the maximum advance is taken.

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