2.5 Exercises

A. Problem: Basic Maturity Matching at Hobson Ltd.

1. 2017	Net Working Capital
   Quarter 1	52,500
   Quarter 2	66,500
   Quarter 3	45,500
   Quarter 4	35,000
   2018
   Quarter 1	55,125
   Quarter 2	69,825
   Quarter 3	47,775
   Quarter 4	36,750

    

   36,750 – 35,000 = 1,750

   1,750 / 4 = 437.50

   55,125 – 35,000 – 437.5 (1) =	19,687.50
   69,825 – 35,000 – 437.5 (2) =	33,950.00
   47,775 – 35,000 – 437.5 (3) =	11,462.50
   36,750 – 35,000 – 437.5 (4) =	0.00

2. Approximately CAD 35,000 as it is forecasted that temporary financing will reach CAD 33,950.00 in Quarter 2.  Additional funds were requested to serve as a safety margin in case temporary financing needs were higher.  The amount of the safety margin is at the discretion of management.
3. In the slowest quarter of the year (Quarter 4 in this case), their temporary financing should be paid down to zero.

B. Problem: Basic Maturity Matching at Juno Company

1. 2017	Net Working Capital
   Quarter 1	49,000
   Quarter 2	50,000
   Quarter 3	56,000
   Quarter 4	47,000
   2018
   Quarter 1	53,900
   Quarter 2	55,000
   Quarter 3	61,600
   Quarter 4	51,700

    

   51,700 – 47,000 = 4,700

   4,700 / 4 = 1,175

   53,900 – 47,000 – 1,175 (1) =	5,725
   55,000 – 47,000 – 1,175 (2) =	5,650
   61,600 – 47,000 – 1,175 (3) =	11,075
   51,700 – 47,000 – 1,175 (4) =	0

2. Approximately CAD 12,000 as it is forecasted that temporary financing will reach CAD 11,075 in Quarter 3. Additional funds were requested to serve as a safety margin in case temporary financing needs were higher. The amount of the safety margin is at the discretion of management.
3. In the slowest quarter of the year (Quarter 4 in this case), their temporary financing should be paid down to zero.

C.Problem: Comprehensive Maturity Matching at Elli Ltd.

1. Maturity of Long-term Assets
   1. [latex]\frac{{25,600,000}}{{2,950,000}} = 8.68{\text{ years}}[/latex]

Maturity of Long-term Debt

1. 1. [latex]\frac{{40,520,000}}{{12,450,000}} = 3.25{\text{ years}}[/latex]
   2. 63% of debt is due within three years

2.

• • Line of credit has not been paid down to zero at year end which is the seasonal low.
  • Long-term assets on average will last another 8.68 years, while the long-term debt will mature in 3.25 years. Loans will have to be rolled over a number of times before the assets are able to generate enough cash flows to pay off the loans.
  • 63% of long-term debt is due within the next three years.
  • 25% of the long-term debt is convertible by investors into common equity, but the current exercise price of CAD 25 and market price of CAD 12.32 do not justify conversion at this time.
  • Elli is exposing itself to rollover risk by not paying down its line of credit at the seasonal low and by not matching the maturities of its long-term assets and long-term debt. This is likely being done to save on interest expense in order to raise profitability.

D. Problem: Comprehensive Maturity Matching at Big Red One Ltd.

1. Maturity of Long-term Assets

[latex]\frac{{35,350,000}}{{4,170,000}} = 8.48{\text{ years}}[/latex]

Maturity of Long-term Debt

[latex]\frac{{15,535,000}}{{7,850,000}} = 1.98{\text{ years}}[/latex]

85% of debt is due within three years

2.

• • A large amount is still owed on the line of credit at year end, which is also the seasonal low. Big Red One may have difficulties paying this large balance down to zero each year, which is required by the lending agreement.
  • There is a sizeable mismatch between the maturity of the long-term assets and the maturity of the long-term debt, which exposes Big Red One to considerable rollover risk. This is serious given the poor economic outlook.
  • 41% (3,200,000/7,850,000) of the long-term debt may be converted into equity. The exercise price in currently below the market price, but this may change with the coming recession.

E. Problem: Cost of Trade Credit

1.

Nominal

[latex]=\frac{{2}}{{98}}{\text{X}}\frac{{365}}{{20}}=.372{\text{ or }}37.2{\text{%}}[/latex]

Effective

[latex]=(1+\frac{{2}}{{98}})^{\frac{{365}}{{20}}}-1=.446{\text{ or }}44.6{\text{%}}[/latex]

2.

[latex]=(1+\frac{{2}}{{98}})^{\frac{{365}}{{35}}}-1=.235{\text{ or }}23.5{\text{%}}[/latex]

3.

• • Damage to credit rating
  • Loss of future trade credit or risk being put on COD or CBD
  • Interest and penalties on overdue accounts
  • Lost early payment discounts

4.

• • Give an indirect price cut to attract new customers
  • Avoid a price war with competing suppliers
  • Avoid having to lower prices charged to existing customers
  • No choice but to match the competition (other suppliers)
  • Reduced credit monitoring and collection costs
  • Cannot borrow from another lending source at a more reasonable rate

5.

[latex]=(1+\frac{{3}}{{97}})^{\frac{{365}}{{75}}}-1=.1598{\text{ or }}15.98{\text{%}}[/latex]

F. Problem: Using a Revolving Credit Agreement at ABC Company

1.

January

[latex]\begin{array}{rcl}(25,000)(.12)(\frac{{13}}{{365}})&=&106.85\\(43,000)(.12)(\frac{{12}}{{365}})&=&169.64\\(38,000)(.12)(\frac{{6}}{{365}})&=&74.96\\&&351.45\end{array}[/latex]

February

[latex]\begin{array}{rcl}(38,000)(.12)(\frac{{2}}{{365}})&=&24.99\\(38,000)(.13)(\frac{{7}}{{365}})&=&94.74\\(30,000)(.13)(\frac{{6}}{{365}})&=&64.11\\(40,000)(.13)(\frac{{13}}{{365}})&=&185.21\\&&369.05\end{array}[/latex]

2.

January

[latex]\begin{array}{rcl}106.85+.0025(\frac{{13}}{{365}})(75,000-25,000)&=&111.30\\169.64+.0025(\frac{{12}}{{365}})(75,000-43,000)&=&172.27\\74.96+.0025(\frac{{6}}{{365}})(75,000-38,000)&=&76.48\\&&360.05\end{array}[/latex]

[latex]=\frac{{360.05}}{{(\frac{{13}}{{31}})(25,000)(.9)+(\frac{{12}}{{31}})(43,000)(.9)+(\frac{{6}}{{31}})(38,000)(.9)}}=\frac{{360.05}}{{31,035.48}}=.0116{\text{ or }}1.16{\text{%}}[/latex]

3.

[latex](1.16{\text{%}})(12)=13.92{\text{%}}[/latex]

G. Problem: Using a Revolving Credit Agreement at Sampson Ltd.

1.

January

[latex]\begin{array}{rcl}(35,000)(.07)(\frac{{8}}{{365}})+(250,000-35,000)(.0025)(\frac{{8}}{{365}})&=&65.48\\(84,000)(.07)(\frac{{12}}{{365}})+(250,000-84,000)(.0025)(\frac{{12}}{{365}})&=&206.96\\(84,000)(.08)(\frac{{5}}{{365}})+(250,000-84,000)(.0025)(\frac{{5}}{{365}})&=&97.73\\(80,000)(.08)(\frac{{6}}{{365}})+(250,000-80,000)(.0025)(\frac{{6}}{{365}})&=&112.19\\&&482.36\end{array}[/latex]

[latex]=\frac{{482.36}}{{(35,000)(\frac{{8}}{{31}})(.94)+(84,000)(\frac{{12}}{{31}})(.94)+(84,000)(\frac{{5}}{{31}})(.94)+(80,000)(\frac{{6}}{{31}})(.94)}}=.0073[/latex]

[latex](.73{\text{%}})(12)=8.76{\text{%}}[/latex]

2.

= (Lessor of limit on line of credit or maximum borrowing allowed based on collateral requirements) – Current borrowing

= (Lessor of 250,000 or 224,900) – 80,000 = $144,900

3.

January is one of the slower months of the year.  More funds will be borrowed during the busier periods of the year.

H. Problem: Using a Revolving Credit Agreement at Hanson Ltd.

1.

January

[latex]\begin{array}{rcl}(550,000)(.07)(\frac{{5}}{{365}})+(1,000,000-550,000)(.005)(\frac{{5}}{{365}})&=&558.22\\(780,000)(.07)(\frac{{14}}{{365}})+(1,000,000-780,000)(.005)(\frac{{14}}{{365}})&=&2,136.44\\(780,000)(.065)(\frac{{5}}{{365}})+(1,000,000-780,000)(.005)(\frac{{5}}{{365}})&=&709.58\\(645,000)(.065)(\frac{{7}}{{365}})+(1,000,000-645,000)(.005)(\frac{{7}}{{365}})&=&838.08\\&&4,242.32\end{array}[/latex]

[latex]=\frac{{4,242.32}}{{(550,000)(\frac{{5}}{{31}})(.8)+(780,000)(\frac{{19}}{{31}})(.8)+(645,000)(\frac{{7}}{{31}})(.8)}}=.0074{\text{ or }}.74{\text{%}}[/latex]

[latex](.74{\text{%}})(12)=8.88{\text{%}}[/latex]

2.

[latex]\begin{array}{rcl}({\text{Collateral required}})({\text{Borrowing %}})&=&{\text{Amount of loan}}\\({\text{Collateral required}})(.6)&=&645,000\\{\text{Collateral required}}&=&1,075,000\end{array}[/latex]

I. Problem: Nominal and Effective Rates

1.

10% for all loans

2.

[latex]\begin{array}{rcl}(1+\frac{{.10}}{{12}})^{12}-1&=&.1047{\text{ or }}10.47{\text{%}}\\(1+\frac{{.10}}{{2}})^{2}-1&=&.1025{\text{ or }}10.25{\text{%}}\\(1+\frac{{.10}}{{1}})^{1}-1&=&.1000{\text{ or }}10.00{\text{%}}\end{array}[/latex]

J. Problem: Mortgage Loan with Blended, Equal Monthly Payments at Rose Company

1.

[latex]\begin{array}{rcl}\frac{{.09}}{{2}}&=&.045\\.045&=&(1+{\text{i}})^{6}-1\\{\text{i}}&=&.0073631\end{array}[/latex]

[latex]\begin{array}{rcl}(750,000)(1-.4)&=&{\text{P}}(\frac{{1-(1+.0073631)^{-180}}}{{.0073631}})\\450,000&=&{\text{P}}(\frac{{1-(1+.0073631)^{-180}}}{{.0073631}})\\{\text{P}}&=&4,520.33\end{array}[/latex]

2.

K. Problem:  Mortgage Loan with Blended, Equal Monthly Payments at Wilson Company

1.

[latex]\begin{array}{rcl}\frac{{.08}}{{2}}&=&.04\\.04&=&(1+{\text{i}})^{6}-1\\{\text{i}}&=&.006558196\end{array}[/latex]

[latex]\begin{array}{rcl}(1,500,000)(.6)&=&{\text{P}}(\frac{{1-(1+.006558196)^{-180}}}{{.006558196}})\\900,000&=&{\text{P}}(\frac{{1-(1+.006558196)^{-180}}}{{.006558196}})\\{\text{P}}&=&8,533.38\end{array}[/latex]

2.

3.

• • Bank may be uncertain of the resale value of the land and wants to ensure that the collateral will cover what is owed if it has to call the loan.
  • Company may be over leveraged, and the bank may want to limit the company’s borrowing.

L. Problem: Mortgage Loan with Blended, Equal Monthly Payments at Belair Ltd.

1.

[latex]\begin{array}{rcl}\frac{{.07}}{{2}}&=&.035\\.035&=&(1+{\text{i}})^{6}-1\\{\text{i}}&=&.00575\end{array}[/latex]

[latex]\begin{array}{rcl}(4,500,000)(.6)&=&{\text{P}}(\frac{{1-(1+.00575)^{-120}}}{{.00575}})\\2,700,000&=&{\text{P}}(\frac{{1-(1+.00575)^{-120}}}{{.00575}})\\{\text{P}}&=&31,210.31\end{array}[/latex]

2.

3.

• • Make a larger down payment by either saving more before purchasing the property or raising new equity capital
  • Increase the amortization period of the loan
  • Negotiate a lower interest rate with another lender

M. Problem: Term Loan with Blended, Equal Monthly Payments at ABC Company

1.

[latex]\begin{array}{rcl}(1,500,000)(1-.25)&=&{\text{P}}(\frac{{1-(1+\frac{{.08}}{{12}})^{-120}}}{{\frac{{.08}}{{12}}}})\\1,125,000&=&{\text{P}}(\frac{{1-(1+\frac{{.08}}{{12}})^{-120}}}{{\frac{{.08}}{{12}}}})\\{\text{P}}&=&13,649.35\end{array}[/latex]

Note:  Interest rate does not have to be converted because the payment period and compounding period are already the same.

2.

N. Problem: Term Loan with Blended, Equal Monthly Payments at Delta Ltd.

1.

[latex]\begin{array}{rcl}\frac{{.06}}{{2}}&=&.03\\.03&=&(1+{\text{i}})^{6}-1\\{\text{i}}&=&.0049386\end{array}[/latex]

[latex]\begin{array}{rcl}(182,500)(1-.4)&=&{\text{P}}(\frac{{1-(1+.0049386)^{-120}}}{{.0049386}})\\109,500&=&{\text{P}}(\frac{{1-(1+.0049386)^{-120}}}{{.0049386}})\\{\text{P}}&=&1,211.63\end{array}[/latex]

2.

3.

• • The injection molding machine is specialized equipment that will likely be difficult to re-sell if the lender has to repossess it.

O. Problem: Term Loan with a Customized Repayment Schedule at Jenkins Company

1.

[latex]\begin{array}{lll}^{1}(500,000)(\frac{{.10}}{{4}})&=&12,500\\^{2}(500,000-50,000)(\frac{{.10}}{{4}})&=&11,250\\^{3}(500,000-50,000(2))(\frac{{.10}}{{4}})&=&10,000\\^{4}(500,000-50,000(3))(\frac{{.10}}{{4}})&=&8,750\\^{5}(500,000-50,000(4))(\frac{{.10}}{{4}})&=&7,500\\^{6}(500,000-50,000(5))(\frac{{.10}}{{4}})&=&6,250\\^{7}(500,000-50,000(6))(\frac{{.10}}{{4}})&=&5,000\\^{8}(500,000-50,000(6))&=&200,000\end{array}[/latex]

2.

I/O – Only interest was paid during the first two quarters

Stepped – Principal payment increased from CAD 0 in 2016 to CAD 50,000 in 2017

Seasonal – No payment in required in the final quarter of the year due to high cash flow needs

Balloon – Principal payments are deferred and a large principal payment is required in the final quarter

P. Problem: Term Loan with a Customized Repayment Schedule at Eaton Inc.

1.

[latex]\begin{array}{lll}^{1}(1,500,000)(\frac{{.07}}{{4}})&=&26,250\\^{2}(1,500,000-150,000)(\frac{{.07}}{{4}})&=&23,625\\^{3}(1,500,000-150,000(2))(\frac{{.07}}{{4}})&=&21,000\\^{4}(1,500,000-150,000(3))(\frac{{.07}}{{4}})&=&18,375\\^{5}(1,500,000-150,000(4))(\frac{{.07}}{{4}})&=&15,750\\^{6}(1,500,000-150,000(5))(\frac{{.07}}{{4}})&=&13,125\\^{7}(1,500,000-150,000(5))(\frac{{.07}}{{4}})&=&750,000\end{array}[/latex]

2.

I/O – Only interest was paid during the first two quarters

Stepped – Principal payment increased from CAD 0 in 2016 to CAD 150,000 in 2017

Seasonal – No payment in required in the third quarter of the year due to high cash flow needs

Balloon – Principal payments are deferred and a large principal payment is required in the final quarter

3.

• • The value of the depreciating collateral should always be more than the amount of the loan to provide sufficient collateral.
  • Will the company have the ability to either pay or rollover the large balloon payment at the end of the loan.