19: Cash, Payables and Liquidity ManagementSupplier 5: 1/10 net 45
Supplier 6: 1/20 net 80
a Determine the interest rate associated with not taking the cash discount and instead paying at
the end of the credit period for each of the six suppliers’ credit terms.
b In part (a), you calculated the interest rate associated with not taking the discount for each
supplier’s credit terms. Now you must decide whether or not to take the cash discount by
paying within the discount period. To pay early, you will need to borrow from your company’s
overdraft at the local bank. The interest rate on the overdraft is the prime rate plus 2.5%.
Suppose the prime rate is currently 5% per annum. For each supplier’s terms, use the current
prime rate to determine whether the company should borrow from the bank or, in effect,
borrow from the supplier.P19-5 Access Enterprises is vetting four possible suppliers of an important raw material used in its
production process, all offering different credit terms. The products offered by each supplier are
virtually identical. The following table shows the credit terms offered by these suppliers. Assume
a 365-day year.
Supplier Credit terms
A 1/10 net 40
B 2/20 net 90
C 1/20 net 60
D 3/10 net 75a Calculate the interest rate associated with not taking the discount from each supplier.
b If the company needs short-term funds (which are currently available from its commercial bank
at 11%) and if each of the suppliers is viewed separately, then which, if any, of the suppliers’
cash discounts should the company not take? Explain why.
c Suppose that the company could stretch its accounts payable to supplier A (net period only)
by 20 days. How would this affect your answer in part (b) concerning this supplier?SHORT-TERM INVESTING AND BORROWING
P19-6 Matthews Manufacturing is negotiating a one-year overdraft with its bank, Worldwide Bank.
The amount of the overdraft is $6.5 million with an interest rate set at 1.5% above the prime
rate. A commitment fee of 0.50% (50 basis points) will be charged on the unused portion of the
overdraft. No compensating balances are required, and the loan is made on a 365-day basis.
a If the prime rate is assumed to be constant at 4.25% during the term of the loan and if
Matthews’ average loan outstanding during the year is $5.0 million, then calculate the
company’s effective borrowing rate (EBR).
b What effect would an increase in the prime rate to 4.75% for the entire year have on
Matthews’ EBR calculated in part (a)?
c What effect would a decrease in Matthews’ average loan outstanding during the year to $4.0
million have on the EBR calculated in part (a)?
d Using your findings in parts (a), (b), and (c), discuss the effects on Matthews’ EBRs of interest-
rate changes versus changes in the average loan outstanding.