C. Charles Smith recently was hired as president of Dellvoe Office Equipment Inc., a small manufacturer of metal office equipment. As his assistant, you have been asked to review the company’s short-term financing policies and to prepare a report for Smith and the board of directors. To help you get started, Smith has prepared some questions that, when answered, will give him a better idea of the company’s short-term financing policies.
a. What is short-term credit, and what are the four major sources of this credit?
b. Is there a cost to accruals, and do firms have much control over them?
c. What is trade credit?
d. Like most small companies, Dellvoe has two primary sources of shortterm debt: trade credit and bank loans. One supplier, which supplies Dellvoe with $50,000 of materials a year, offers Dellvoe terms of 2/10, net 50.

(1) What are Dellvoe’s net daily purchases from this supplier?
(2) What is the average level of Dellvoe’s accounts payable to this supplier if the discount is taken? What is the average level if the
discount is not taken? What are the amounts of free credit and costly credit under both discount policies?
(3) What is the APR of the costly trade credit? What is its rEAR?
e. In discussing a possible loan with the firm’s banker, Smith found that the bank is willing to lend Dellvoe up to $800,000 for one year at a 9 percent simple, or quoted, rate. However, he forgot to ask what the specific terms would be.
(1) Assume the firm will borrow $800,000. What would be the effective interest rate if the loan were based on simple interest? If the loan had
been an 8 percent simple interest loan for six months rather than for a year, would that have affected r_EAR?

(2) What would rEAR be if the loan were a discount interest loan? What would be the face amount of a loan large enough to net the firm $800,000 of usable funds?
(3) Assume now that the terms call for an installment (or add-on) loan with equal monthly payments. The add-on loan is for a period of one year. What would be Dellvoe’s monthly payment? What would be the approximate cost of the loan? What would be rEAR?
(4) Now assume that the bank charges simple interest, but it requires the firm to maintain a 20 percent compensating balance. How much must Dellvoe borrow to obtain its needed $800,000 and to meet the compensating balance requirement? What is rEAR on the loan?
(5) Now assume that the bank charges discount interest of 9 percent and also requires a compensating balance of 20 percent. How much must Dellvoe borrow, and what is rEAR under these terms?
(6) Now assume all the conditions in Part 4—that is, a 20 percent compensating balance and a 9 percent simple interest loan—but assume also that Dellvoe has $100,000 of cash balances that it normally holds for transactions purposes, which can be used as part of the required compensating balance. How does this affect (i) the size of the required loan and (ii) rEAR of the loan?
f. Dellvoe is considering using secured short-term financing.What is a secured loan? What two types of current assets can be used to secure loans?
g. What are the differences between pledging receivables and factoring receivables? Is one type generally considered better?
h. What are the differences among the three forms of inventory financing? Is one type generally considered best?
i. Dellvoe had expected a really strong market for office equipment for the year just ended, and in anticipation of strong sales, the firm increased its inventory purchases. However, sales for the last quarter of the year did not meet Dellvoe’s expectations, and now the firm finds itself short on cash. The firm expects that its cash shortage will be temporary, lasting only three months. (The inventory has been paid for and cannot be returned to suppliers.) Dellvoe has decided to use inventory financing to meet its short-term cash needs. It estimates that it will require $800,000 for inventory financing during this three-month period. Dellvoe has negotiated with the bank for a three-month, $1,000,000 line of credit with terms of 10 percent annual interest on the used portion, a 1 percent commitment fee on the unused portion, and a $125,000 compensating balance at all times. Expected inventory levels to be financed are as follows:

Month........................................ Amount
January..................................... $800,000
February..................................... 500,000
March.......................................... 300,000

Calculate the cost of funds from this source, including interest charges and commitment fees.