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Finma

1. The company borrowed a total of $80M at an interest rate of prime plus 3% over the course of January to July. To calculate the borrowing cost, the interest rate for each loan must be calculated using the prime rate at the time of borrowing and summed along with the commitment fee. 2. For the month of June, Arcturus incurred $51,040 in bank charges on its $10M revolving credit agreement at prime plus 2.5% and a 0.25% commitment fee based on interest charged on amounts borrowed and unused balances. 3. For a $2M loan at 10% interest where only $1.2M was borrowed

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116 views3 pages

Finma

1. The company borrowed a total of $80M at an interest rate of prime plus 3% over the course of January to July. To calculate the borrowing cost, the interest rate for each loan must be calculated using the prime rate at the time of borrowing and summed along with the commitment fee. 2. For the month of June, Arcturus incurred $51,040 in bank charges on its $10M revolving credit agreement at prime plus 2.5% and a 0.25% commitment fee based on interest charged on amounts borrowed and unused balances. 3. For a $2M loan at 10% interest where only $1.2M was borrowed

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WORKING CAPITAL

Prompt Payment Discount


Passing up prompt payment discounts is an expensive source of financing.

If terms are 2/10, net 30, and don’t pay by the 10th day, essentially paying 2% for 20 days’ use of money
The implied annual rate is (365 / 20) x 2% = 36.5%

Revolving Credit Agreements


Arcturus has a $10M “revolver” at prime plus 2.5%. Prior to June 1, it took down $4M that remained
outstanding for the month. On June 15, it took down another $2M which remained outstanding through
June 30. Prime is 9.5% and the bank’s commitment fee is 0.25%. What bank charges will Arcturus incur
for the month of June?

SOLUTION:
Monthly interest rate: (Prime + 2.5%)  12 = 1%
Monthly commitment fee: 0.25%  12 = 0.0208%

$4M was outstanding for the entire month of June and $2M was outstanding for 15 days, so the
total interest charges are: ($4,000,000 × .01) + ($2,000,000 × [15/30] × .01) = $50,000

The unused balance was $6M for 15 days and $4M for 15 days
($6,000,000 × .000208 × [15/30]) = $ 624
($4,000,000 × .000208 × [15/30]) = $ 416
$1,040
So, total bank charges for June are $51,040

Evaluating Lock-Box Systems


Kelso is located on the East Coast, but has California customers that remit 5,000, $1,000 checks a year
that take eight days to clear.

A California bank offers a lock box system for $2,000 a year plus $0.20 per check, which will reduce
clearing time to six days. Is the proposal a good deal if Kelso borrows at 12%?

Evaluating Lock-Box Systems Solution:

Kelso’s float now


[(8 / 365) x $5,000,000] = $109,589
Float under proposed lockbox system
[(6 / 365) x $5,000,000] = $82,192
Interest on cash freed up
[$27,397 x 0.12] = $3,288
System cost [$2,000 + ($0.20 x 5,000)] = $3,000

Conclusion: Proposal is marginally worth doing


Economic Order Quantity (EOQ) Model
EOQ – An inventory cost minimization model
– Carrying Cost – Annual cost of holding a unit in inventory
– Ordering Cost – Fixed cost of placing an order and receiving the goods

– Objective: Find the order size that minimizes the sum of Carrying and Ordering Costs

EOQ Variables and Formula

C = Annual Carrying Cost per Unit


F = Fixed Cost per Order
D = Annual Demand in Units
Q = Order Quantity

Carrying Cost = cost per unit × average units


= C × (Q / 2)
Ordering Cost = Cost per order × Orders per year
= F × (D / Q)
Total Cost = Carrying Cost + Ordering Cost

(EOQ) Model
EOQ minimizes the sum of
ordering and carrying costs

C = Annual Carrying Cost per Unit


F = Fixed Cost per Order
D = Annual Demand in Units

EXAMPLE:
Galbraith buys a $5 part. Its carrying cost is 20% of that value per year.
It costs $45 to place, process and receive an order.
1,000 parts are used per year.

What order quantity minimizes inventory costs?


How many orders will be placed each year if that order quantity is used?
What annual inventory costs are incurred for the part with this ordering quantity?
Questions

1.) In Jan 1 the Company borrowed 50 million at prime plus 3%. On April 1 2019, the company took out a loan of 10
million. On July 1, they took out 20 million. The prime rate (interest rate) is 9% and the bank’s commitment fee is
36%.

Compute for:
Interest rate
The Commitment fee
Borrowing cost

2.) Arcturus has a $10M “revolver” at prime plus 2.5%. Prior to June 1, it took down $4M that remained
outstanding for the month. On June 15, it took down another $2M which remained outstanding through June 30.
Prime is 9.5% and the bank’s commitment fee is 0.25%.

Compute for:
Interest rate
The Commitment fee
Borrowing cost

3.) The company Entered in to a 2 million loan with 10% interest rate and compensating balance (minimum
balance) of 15%. However, the company only borrowed 1.2 million.

Compute:
Interest paid

Effective interest rate

4.) The company Entered in to a 50 million loan. However, the company only borrowed half for an interest rate of
12% and a 15% compensating balance

Compute:
Effective Interest rate

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