25. Unsecured Bank Loans Q: A firm borrows $100,000 subject to a 20% compensating balance. The firm will only receive $80,000 in usable funds and the remaining $20,000 must remain in the firm’s account. If the stated rate on the loan is 12%, what is the effective rate? A: The firm must pay the 12% on the entire $100,000 borrowed. Thus, the firm will pay $12,000 in interest for a year on $80,000 of usable funds. This translates to an effective annual rate of 15%, or $12,000 $80,000. Example
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31. Short-Term Credit Secured by Current Assets—Example Q: The Kilraine Quilt Company has an average receivables balance of $100,000 which turns over once every 45 days. It generally pledges all of its receivables to the Kirkpatrick County Cooperative Finance Company, which advances 75% of the total at 4% over prime plus a 1.5% administrative fee. If prime is 11%, what total interest rate is Kilraine effectively paying for its receivables financing? A: Since the finance company advances 75% of the receivables balance, the average loan amount is $75,000. Interest at 4% over prime is 15%. The firm pledges all of its receivables, thus $800,000 in new receivables are pledged each year ($100,000 x 360/45). The administrative fee of 1.5% is charged on this amount and is $12,000, or 1.5% x $800,000. This amounts to 16% of the average loan balance ($12,000 $75,000), thus the annual interest rate is 16% + 15%, or 31%. Example
39. Figure 15.6: A Lock Box System in the Check-Clearing Process
40. Lock-Box Example Q: Kelso Systems Inc. operates primarily on the East Coast, but has a cluster of customers in California that remit about 5,000 checks a year. The average check is for $1,000. West Coast checks currently take an average of eight days from the time they are mailed by customers to clean into Kelso’s East Coast account. A California bank has offered Kelso a lock box system for $2,000 a year plus $0.20 per check. The system can be expected to reduce the clearing time to six days. Is the bank’s proposal a good deal for Kelso if it borrows at 12%? A: On average Kelso has $109,589 tied up in cash, or [(8 365) x $1,000 x 5,000] but the proposed lockbox system will reduce this to $82,192, or [(6 365) x $1,000 x 5,000]; thus, freeing up $27,397 of cash. Kelso will be able to borrow $27,397 less, thus saving $3,288 in interest [$27,397 x 0.12]. The system is expected to cost $3,000, or [$2,000 + ($0.20 x 5,000)]. Hence, the bank’s proposal is only marginally worth doing. Example
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53. Economic Order Quantity (EOQ) Model—Example Q: The Galbraith Corp. buys a part that costs $5. The carrying cost of inventory is approximately 20% of the part’s dollar value per year. It costs $45 to place, process and receive an order. The firm uses 1,000 of the $5 parts per year. What ordering quantity minimizes inventory costs and how many orders will be placed each year if that order quantity is used? What inventory costs are incurred for the part with this ordering quantity? A: Since the unit carrying cost is 20% of the part’s price, the annual carrying cost per unit in dollars is $1, or 20% x $5. Substituting the known information into the EOQ equation, we have: Example The annual number of reorders is 1,000 300, or 3.33. Carrying costs are $150 a year, or (300 2) x $5 x 20%; and ordering costs are $45 x 3.333, or $150. The total inventory cost of the part is $300.