BBPW3203 FINANCIAL MANAGEMENT II By : DANIZAH BINTI CHE DIN H/P : CLASS : TUTORIAL 1 – 12/1/2013 TUTORIAL 2 – 23/2/2013 TUTORIAL 3 – 9/3/2013 TUTORIAL 4 – 23/3/2013 ASSESSMENT : ASSIGNMENT [40%] – 10 MARCH 2013 FINAL EXAM [60%] ASSESSMENT : ASSIGNMENT [40%] – 10 MARCH 2013 FINAL EXAM [60%]

CHAPTER 1 SHORT – TERM FINANCING

By the end of this tutorial, you should be able to :  Differentiate between accounting and finance.  Explain the importance of financial management.  Identify the objective of a firm.  Discuss the roles of financial manager in a firm.  Elaborate the characteristics, the advantages, & the weaknesses of each type of business.  Discuss the challenges of financial management in the future.

 Refer to a finance that must be paid within a year.  Current assets policy.  A tool to finance the account receivable and to building up the inventory.  Similar to short-term but able to fulfill requirement for permanent funding.  Self-liquiditing.  Debt more than a year.  To finance a fixed assets.  The repayment is arrange and schedule.

1.Temporary Current Assets 2. Permanent Current Assets  The cycle of current assets value is affected by the economy growth.  Seasonal fluctuation. The current assets is maintained all the time even though the economic is slack.

RM TIME PERIOD Long-term Financing Zero Short-term Financing Fixed Assets Permanent Current Assets Marketable Securities / Excess Liquidity Temporary Current Assets  Used some of the long term financing such as bond to finance some of the temporary current assets.  Received the least risk & the lowest expected return.  Used some of the long term financing such as bond to finance some of the temporary current assets.  Received the least risk & the lowest expected return.

Time Period Short-TermExcess Fixed Assets Permanent Current Assets Temporary Current Assets RM Long-Term Financing Liquidity  Used short-term financing to finance the temporary current assets & used long-term finance to finance the permanent current assets & fixed assets.  Minimize risk & maximize the expected return.  Used short-term financing to finance the temporary current assets & used long-term finance to finance the permanent current assets & fixed assets.  Minimize risk & maximize the expected return.

 Used some of the temporary capital to finance part of the permanent assets.  Promised the highest return but greater risk.  Used some of the temporary capital to finance part of the permanent assets.  Promised the highest return but greater risk. Short-Term Financing Fixed Assets Permanent Current Assets Temporary Current Assets TIME PERIOD RM Long-Term Financing

 Cash flow from operations may not be sufficient to keep up with growth-related financing needs.  Firms may prefer to borrow now for their inventory or other short term asset needs rather than wait until they have saved enough.  Firms prefer short-term financing instead of long-term sources of financing due to:  easier availability  usually has lower cost (remember yield curve)  matches need for short term assets, like inventory

ADVANTAGES  Lower cost.  Easy to get fund with low transactions cost.  No penalty repayment. DISADVANTAGES :  More riskier than long- term.  Rates increased.

1.SPONTANEOUS FINANCING Referring to normal and daily operations which do not require any collateral such as Accruals & Account Payable or Trade Credits. 2.NON-SPONTANEOUS FINANCING Not a normal or daily operations that needs collateral such as bank loan and commercial paper. 3.ALTERNATIVE SOURCES OF FINANCING Factoring, account receivable financing, inventory financing and others.

Is there a cost to accruals? Do firms have much control over amount of accruals?  Accruals are free in the sense that no explicit interest is charged.  However, firms have little control over accrual levels, which are influenced more by industry custom, economic factors, and tax laws than by managerial actions.

WHAT IS TRADE CREDIT?  Trade credit is credit furnished by a firm’s suppliers when delaying a payment.  Trade credit is often the largest source of short- term credit for small firms.  Trade credit is spontaneous and relatively easy to get, but the cost can be high.

NET PRICE WITHOUT CASH DISCOUNT  Credit terms of payment 15/EOM.  Payment needs to be made within 15 days and the latest in the end of the month. NET PRICE WITH CASH DISCOUNT  Credit terms of payment 2/10, net 30.  Payment need to be paid within 10 days to enjoy 2% discount and payment made on day 11 th onwards, no discount will be given.  Latest payment should be made were within 30 days.

GIVING THE CASH DISCOUNT & TAKING EXTENDED CREDIT  Payment made on the last date of discount period. To obtain Effective Annual cost Rate of trade credits :

B&B buys RM3,030,303 gross, or RM3,000,000 net, on terms of 1/10, net 30. However, the firm pays on Day 30. Giving up the cash discount – paid Day 30. Annual Financing Cost (AFC)= = (1/100 – 1) x (360/30 – 10) = xxx Effective Annual cost Rate (EAR)= = = zzz%

COMMERCIAL PAPER  Short term notes issued by large, strong companies.  Trades in the market at rates just above the T-bill rate.  Bought by banks and other companies, then held as marketable securities for liquidity purposes.

 Most firms used bank loans as a major source of finance after trade credit.  The firm can borrow up to the limit set by a bank after reviewing the firm cash budget.  A written agreement.  Two basic categories of loan :  Secured loan – collateral.  Unsecured loan Promissory notes. Compensating balance Revolving credit agreement Line of credit.

Bank require borrower to maintain an average demand deposit balance which equal to 10 to 20 percent of the loan face value. Bank requires a compensating balance of 20% of the loan face value. The bank short-term loan taken was RM 10,000 and will be mature in 12 months. If bank interest charge is 10%, what should be the AFC? Amount borrowed= RM 10,000 Compensating Balance= RM 10,000 x 20% = RM 2,000 Fund Available for used (PV)= RM 10,000 – RM 2,000 = RM 8,000 Interest (r)= RM 10,000 x 10% = RM 1,000 Amount to be repaid (FV)= RM 8,000 + RM 1,000 = RM 9,000

Amount borrowed= RM 10,000 Compensating Balance= RM 10,000 x 20% = RM 2,000 Fund Available for used (PV)= RM 10,000 – RM 2,000 = RM 8,000 Interest (r)= RM 10,000 x 10% = RM 1,000 Amount to be repaid (FV)= RM 8,000 + RM 1,000 = RM 9, % AFC= r/PV = RM 1,000/RM 8,000= 12.5%

Borrowing limit set by bank. Amount borrowed (PV)= RM 200,000 Interest (Jan – March) (i1)= RM 200,000 x ( ) x (90/360) = RM 3, Interest (Apr - Dec) (i2)= RM 200,000 x ( ) x (275/365)= RM 11, Total Interest (r)= i1 + i2 = RM 3, RM 11, = RM 14, AFC =i / PV= RM 14,753.42/RM 200,000 = 7.377%

1.Regular & Simple interest – based on interest-only loan. 2.Discount interest – interest is deducted in advance. 1.Interest only  Only interest is paid during life of loan. Principle paid when loan is matured. 2.Amortized  Both principal & interest paid in each period on equal basis.

A bank is willing to lend B&B RM100,000 for 1 year at an 8 percent nominal rate. What is the EAR under the following four loans? 1.Simple annual interest, 1 year. 2.Simple interest, paid monthly. 3.Discount interest. 4.Discount interest with 10 percent compensating balance. Amount borrowed (PV)= RM 100,000 Nominal rate (r)= 8% Interest rate (i)= RM 100,000 x 8%= RM 8,000

Simple annual interest, 1 year. AFC= i / PV = RM 8,000 / RM 100,000= 8% Simple interest, paid monthly. EAR= [1+(0.08/12)] - 1 = 8.3% Discount interest. Amount borrowed = RM 100,000 Nominal rate (r)= 8% Interest rate (i)= RM 100,000 x 8%= RM 8,000 Useable fund (PV)= RM 100,000 – RM 8,000 = RM 92,000 Amount needed (FV)= RM 100,000 AFC= [FV / PV] – 1= [RM 100,000 / RM 92,000]-1 = 8.7%

Discount interest with 10% compensating balance. Amount borrowed= RM 100,000 / ( ) = RM 121, Compensating Balance= RM 121, x 10% = RM 12, Interest rate (i)= RM 121, x 8%= RM 9, Useable fund (PV)= RM 121, – RM 12, – RM 9, = RM 100,000 Amount needed (FV)= RM 100, RM 9, = RM 109, AFC= [FV / PV] – 1= [RM 109, / RM 100,000]-1 = 9.76%