Sources of Short- and Intermediate-Term Funds

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
percentage discount 100-percentage discount

• i

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 is98(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