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BEC8 - Financing Current Assets

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What are permanent current assets?
Those required to operate the business in even the slowest times of the year.
What are temporary current assets?
The additional amounts of current assets that are accumulated during periods of higher production and sales.
What is a conservative approach to current assets?
To finance permanent current assets with long-term financing sources and finance temporary current assets with short-term financing sources.
Name three disadvantages of long-term financing sources.
1. more expensive
2. have more covenants that restrict management actions
3. often have prepayment penalties
Name six short-term sources of funds.
1. accounts payable (trade credit)
2. short-term bank loans
3. commercial paper
4. loans with accounts receivable as collateral
5. debt with inventory as collateral
6. selling derivatives in the financial futures market
Name a disadvantage of using accounts payable as a short-term source of funds.
It can be expensive if the firm does not take advantage of the cash discounts available for early payment of invoices.
What are a short-term bank loans?
Loans from financial institutions that typically mature in about 90 days and involve an interest rate tied to the prime rate or the London Interbank Offered Rate (LIBOR).
What is the nominal rate on a short-term bank loan?
The prime rate or LIBOR.
What is the actual rate on a short-term bank loan?
The prime rate or LIBOR adjusted for the borrower's credit risk.
How is the interest cost calculated when the loan is made on a discounted basis or involves a compensating balance?
Divide the interest amount by the cash available (the principal minus the discount or compensating balance).
What is a line of credit?
An informal specification of the maximum amount that the bank will lend the borrower.
What is a letter of credit?
A promise by an importer's bank that the bank will pay for imported merchandise - it facilitates international trade.
Who can issue commercial paper to obtain short-term funds?
Large credit worthy borrowers.
Name the three ways in which accounts receivable can be used as collateral for short-term loans.
1. pledging of receivables
2. factoring of receivables
3. asset-backed public offerings
Name the three ways in which inventory can be used as collateral for short-term debt.
1. blanket inventory liens
2. trust receipts
3. warehousing arrangements
How can management hedge against interest rate risk if there is a large amount of variable rate debt?
By selling derivatives in the financial futures market.

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