Question 2 You work in the treasury department of a manufacturing company and ha

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Question 2 You work in the treasury department of a manufacturing company and have been tasked to prepare a short-term financial plan for the coming year. The projected sales forecasts for the next five quarters are, respectively, $210m, $180m, $245m, $280m, and $240m. The firm sells on credit and takes, on average, 30 days to collect from its customers; $68m in receivables are currently outstanding. Also, the firm orders a quarter in advance on credit—purchases in a given quarter is 60% of next quarter’s sales and the firm typically takes 50 days to pay its suppliers. Quarterly selling, general, and administrative expenses are estimated to be 25% of corresponding quarterly sales, and the firm expects to pay quarterly dividends of $12m. The purchasing manager plans to acquire a high-performance machine in the second quarter for $160m. The firm would like to maintain a consistent cash balance of $10m in a non-interest bearing bank account. Although it currently has $64m in cash, it would like to redirect excess cash to short-term money market investments. Shortfalls, should they occur, are to be financed to achieve the target cash balance as well. 90-day commercial paper with a face value of $100,000 is selling at $98,814 and Treasury bills of a similar maturity are selling at 99.11% of par value; yields of both instruments are expected to remain stable over time. The firm has a $400m line of credit with a quoted quarterly rate of 1.6% and a compensating balance of 5%, which should be sufficient for its short-term financing needs. However, it also has the option to factor its receivables at a 1.5% discount. Compare the effective rate for the line of credit and the factoring of receivables. Which is the less costly option for the firm to finance its cash deficits?

Explanation / Answer

1. Effective rates

A.Line of credit - Quarterly rate of 1.60%

B. Receivables, the rate is 1.5% discount for 30 days, converting the quarterly rate into 4.5%.

2. Effective rates for commercial paper and treasury bill for 90 days

Out of the 4 options, treasury bills is the cheapest option to finance the short-term cash defecits.

Commercial paper Treasury bill Face value                    100,000.0       100,000.0 Selling value                      98,814.0         99,110.0 Difference                        1,186.0               890.0 Cost of funding (Selling-face)/selling 1.20% 0.90%

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