Solution manual managerial accounting and finance for hospitality OperationsCHAPTER 16

CHAPTER 16
SHORT-TERM FINANCING
I.

Questions
1.

Short-term debt financing refers to debt originally scheduled for repayment
within one year. Short-term financing may be either unsecured or secured.
Secured credit requires collateral whereas unsecured credit does not.

2.

Short-term financing may be classified as spontaneous or negotiated.
Spontaneous sources arise from ordinary business transactions whereas
negotiated sources require special effort. Spontaneous sources include accounts
payable and accruals. Negotiated short-term credit consists of bank loans,
commercial paper, accounts receivable loans, and inventory loans.

3.

Trade credit is short-term credit extended by suppliers of goods and services.
Open accounts, notes payable, and trade acceptances are all types of credit but
open accounts are the most widely used. Unlike the other two types of shortterm trade credit, an open account is an informal arrangement.

4.

Accruals are current liabilities for services rendered but for which payments
have not been made. Accruals include wages, taxes, rent, and interest payable
and are spontaneous sources of short-term financing.

5.

A line of credit is an informal borrowing agreement in which a bank agrees to
extend credit up to a specific amount.

6.

Commercial paper is a short-term obligation with maturities ranging from 2 to
270 days issued by banks, corporations, and other borrowers to investors with
temporarily idle funds. Such instruments are unsecured and usually discounted.

II. Practical Problems
PROBLEM 1
1.

ANC

=

2%
100% – 2%

=

14.69%

x

360
60 – 10

16-2
2.

Solutions Manual - Managerial Accounting and Finance for Hospitality Operations

ANC

=

1%
100% – 1%

=

72.7%

360
20 – 15

x

PROBLEM 2

The effective annual cost to Pepcoke can be calculated as follows:
P9,000,000* + P100,000
Rate
=
x

P100 Million − P100,000 − P9 million
=
*

Interest

1
270
360

13.35%
= P100 Million x 12% x

270
360

= P9 million
PROBLEM 3

1.
Effective rate

=
=

2.

P10,000 (0.10)
P10,000 – P10,000 (0.10)

P1,000
P9,000

=

11.1%

Approximate effective rate =

P1,000 / P5,000 =

20.0%

3.
Effective rate

10%
1 – 0.15 – 0.10

=

=

13.3%

4.
P10,000
1 – 0.15 – 0.10

=

P13,333,

since 0.15 (P13,333) = P2,000 is required for the compensating balance, and
0.10 (P13,333) = P1,333 is required for the immediate interest payment.
PROBLEM 4
The effective rate is equal to net interest expense divided by proceeds received not
proceeds borrowed.


Short-term Financing

Interest
Proceeds

120,000 – (0.06 x 100,000)
1,000,000 – 100,000

=

=

16-3

12.67%

PROBLEM 5
The discounted interest cost of the commercial paper issue is calculated as follows:
Interest expense = 0.10 x P200 million x 180 / 360 = P10 million
The effective cost of credit can now be calculated as follows:

P10 million + P125,000
RATE
= P200 million – P125,000 – P10 million
=

x

1
180 / 360

10.66%

PROBLEM 6
Cost of not taking a
cash discount
=

2%
98%

Discount %
100% – Disc. %

=

x

360
(55 – 10)

x

360
Final due date –
Discount period

= 2.04% x 8 = 16.32%

Effective rate of interest with a 20% compensating balance requirement:
=
=
=

Interest rate / (1 – C)
14% / (1 – 0.2)
14% / (0.8) = 17.5%

The effective cost of the loan, 17.5%, is more than the cost of passing up the
discount, 16.32%. Kiwi Food Service, Inc. should continue to pay in 55 days and
pass up the discount.
PROBLEM 7
1.

Trust Bank
Effective interest rate
=

2 x 4 x P9,000
(P100,000 – P20,000 – P9,000) x (4 + 1)

=

P72,000 / P355,000 = 20.28%


16-4

Solutions Manual - Managerial Accounting and Finance for Hospitality Operations

Northeast Bank
Effective interest rate
=
=

2 x 12 x P9,000
(P100,000 – P10,000) x (12 + 1)
P216,000 / P1,170,000 = 18.46%

Choose Northeast Bank since it has the lowest effective interest rate.
2.

The numerators stay the same as in part (a) but the denominator increases to
reflect the use of more money because compensating balances are already
maintained at both banks.
Trust Bank
Effective interest rate

=
=

P72,000 / (P100,000 – P9,000) x 5
P72,000 / P455,000 = 15.82%

=
=

P216,000 / (P100,000 x 13)
P216,000 / P1,300,000 = 16.62%

Northeast Bank
Effective interest rate
3.

Yes. If compensating balances are maintained at both banks in the normal
course of business, then Trust Bank should be chosen over Northeast Bank. The
effective cost of its loan will be less.