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Chapter
Copyright 2009 by The McGraw-Hill Companies, Inc. All
McGraw-Hill/Irwin
Chapter Outline
Trade credit from suppliers Bank loans Commercial paper Borrowing larger amounts Using hedging to offset the risk
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Financing Arrangements
Lines of credit are sometimes referred to as a revolving credit facility where interest cost:
Is based on LIBOR (the London Interbank Offered Rate) Is based on the companys senior unsecured credit rating a percentage margin
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Trade Credit
Approximately 40 percent of short-term financing is in the form of accounts payable or trade credit
Accounts payable
Is a Spontaneous source of funds Grows as the business expands Contracts when business declines
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Payment Period
Trade credit is usually extended for 3060 days Extending the payment period to an unacceptable period results in:
Alienate suppliers Diminished ratings with credit bureaus
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Net-Credit Position
Determined by examining the difference between accounts receivable and accounts payable
Positive if accounts receivable is greater than accounts payable and vice versa Larger firms tend to be net providers of trade credit (relatively high receivables) Smaller firms in the relatively user position (relatively high payables)
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Bank Credit
Provide self-liquidating loans
Use of funds ensures a built-in or automatic repayment scheme
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Compensating Balances
A fee charged by the bank for services rendered or an average minimum account balance
When interest rates are lower, the compensating balance rises Required account balance computed on the basis of:
Percentage of customer loans outstanding Percentage of bank commitments towards future loans to a given account
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Maturity Provisions
Term loan
Credit is extended for one to seven years Loan is usually repaid in monthly or quarterly installments Only superior credit applicants, qualify Interest rate fluctuates with market conditions
Interest rate may be tied to the prime rate or LIBOR
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When dollar amounts are used and the stated rate is not known, the following can be used for computation: Days in a
Effective rate with = Interest year (360) compensating balances Principal Compensating Days loan is balance in dollars outstanding
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Book-entry transactions
Computerized handling of commercial paper, where no actual certificate is created
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Foreign Borrowing
Eurodollar loan
Denominated in dollars and made by foreign bank holding dollar deposits Short-term to intermediate terms in maturity LIBOR is the base interest paid on loans for companies of the highest quality
Advantage:
Permits borrowing to be tied directly to the level of asset expansion at any point of time
Disadvantage:
Relatively expensive method of acquiring funds
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Factoring Receivables
Receivables are sold outright to the finance company
Factoring firms do not have recourse against the seller of the receivables Finance companies may do all or part of the credit analysis to ensure the quality of the accounts Factoring firm is:
Absorbing risk for which a fee is collected Actually advancing funds to the seller paid a lending rate
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Inventory Financing
Factors influencing use of inventory:
Marketability of the pledged goods Associated price stability Perishability of the product Degree of physical control that the lender can exercise over the product
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Stages of Production
Stages of production
Raw materials and finished goods usually provide the best collateral Goods in process may qualify only a small percentage of the loan
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Warehousing
A receipt issue goods can be moved only with the lenders approval Public warehousing Field warehousing
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The purchase price of the futures contract is established at the time of the initial purchase transaction
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