1. 6/30/2015Working Capital: Short Term Liabilities1 Working Capital: Short-Term Liabilities

2. 6/30/2015Working Capital: Short Term Liabilities2 Sources of Short Term Funds 1. Trade Credit 2. Bank Borrowing (Prime Rate) 3. Commercial Paper (Direct or Dealer Placed) 4. Accounts Receivable Financing (Factoring) 5. Inventory Financing

3. 6/30/2015Working Capital: Short Term Liabilities3 Bank Credit Terminology Prime Rate: – the interest rate charged to a bank’s better customers (large strong companies don’t borrow from a bank) – acts as a benchmark for calculating other interest rates –note that the prime rate is related to but not the same as the fed funds rate, EURIBOR, or LIBOR. Compensating Balance: – when a bank requires a minimum average account balance for business customers in order to qualify for a loan – can be thought of as a form of collateral Effective Interest Rate: – the actual interest rate or “true” cost of a loan – adjusts the APR for compounding LIBOR (London Interbank Offered Rate): – rate that most international banks charge one another for dollar-denominated loans in the London market. Euro bond market is unregulated.

4. 6/30/2015Working Capital: Short Term Liabilities4 Example Rates Money Rates as of April 23, 2008 IndicatorValue Prime Rate5.25 30 Year T-Bond4.56 10 Year T-Note3.67 91 Day T-Bill1.32 Fed Funds2.25 LIBOR 3 Month2.92 30 Year Mortgage5.82 Some sites for rate information: http://www.forecasts.org/inte rest-rate/fed-funds-interest- rate.htmhttp://www.forecasts.org/inte rest-rate/fed-funds-interest- rate.htm http://www.bankrate.com/br m/ratehm.asphttp://www.bankrate.com/br m/ratehm.asp

5. 6/30/2015Working Capital: Short Term Liabilities5 Turning Short-Term Interest Rates Into Annual Rates Effective Annual Rate = Short-Term Rate X Days in the year Days loan is outstanding Example:Borrow$10,000 Interest$800 Period150 days Effective Annual = $800 X 360 =19.2% Rate $10,000 150

6. 6/30/2015Working Capital: Short Term Liabilities6 Cost of Trade Credit Implicit cost of trade credit = Discount % X 360 100% - Discount % Final Due Date - Discount Period

7. 6/30/2015Working Capital: Short Term Liabilities7 Cost of Trade Credit Example Terms:2/10 net 30 Actual:pay in 45 days For every $100 of payment: 2 = 2.04% 98 Pay in 30 days 2 X 360 = 36.73% 98 20 Pay in 45 days 2 X 360 = 20.99% 98 35

8. 6/30/2015Working Capital: Short Term Liabilities8 Cost of Installment Loan Effective rate on installment = 2 X Annual no. of payments X Interest loan (Total no. of payments + 1) X Principal Grant’s Approximate = Interest rate Average Amount of Loan Salesmen’s = Interest stated rate Amount of Loan

9. 6/30/2015Working Capital: Short Term Liabilities9 Cost of Installment Loan Example Borrow$10,000 Interest $1,000 Payments 12 payments of $916.67 Salesmen’s 1,000= 10% stated rate 10,000 Grant’s Approximate 1,000= 20% rate 5,000 Effective2 X 12 X $1,000= 18.5% rate 13 X $10,000

10. 6/30/2015Working Capital: Short Term Liabilities10 Cost of a Discount Loan Effective= Interest rate Principal - Interest Example Borrow$10,000 Interest10% Effective rate = 1,000 = 11.11% 10,000 - 1,000

11. 6/30/2015Working Capital: Short Term Liabilities11 Cost of Loan with Compensating Balance Effective = Interest rate rate (1- c) where c = compensating balance expressed as a decimal Example: Borrow$10,000 Interest10% Compensating balance20% Effective = 10% = 12.5% rate 1 -.2 Effective = $1,000 = 12.5% rate $10,000 - $2,000 or

12. 6/30/2015Working Capital: Short Term Liabilities12 Movement of Prime Rate and the London Interbank Offer Rate on U.S. Dollar Deposits

13. 6/30/2015Working Capital: Short Term Liabilities13 Commercial Paper Characteristics Short-term (3 months is common) Unsecured IOU from large prestigious firms $25,000 minimum Finance paper or direct paper (i.e.,GMAC) Dealer paper (Industrial Companies) Interest is below prime Low default risk Good marketability

14. 6/30/2015Working Capital: Short Term Liabilities14 Comparison of Commercial Paper Rate to Prime Rate*

15. 6/30/2015Working Capital: Short Term Liabilities15 Total Commercial Paper Outstanding

16. 6/30/2015Working Capital: Short Term Liabilities16 Accounts Receivable Financing Pledging Accounts Receivable Factoring Receivables Asset-Backed Public Offerings

17. 6/30/2015Working Capital: Short Term Liabilities17 Inventory Financing Stages of Production Raw Materials Work-In-Process Finished Goods Nature of Lender Control Blanket Liens Trust Receipts Warehousing (Bonding)