Problem 16.7 Bolly India Enterprises (A) BollyIndia Enterprises has sold a combination of films and DVDs to Brazilia Media Incorporated for 1,000,000, with payment due in 3 months. BollyIndia Enterprises has the following alternatives for financing this receivable: (1) Use its bank credit line. Interest would be at the prime rate of 8% plus 250 basis points per annum. BollyIndia Enterprises would need to maintain a compensating balance of 20% of the loan's face amount. No interest will be paid on the compensating balance by the bank. (2) Use its bank credit line but purchase export credit insurance for a 1% fee. Because of the reduced risk, the bank interest rate would be reduced to 5% per annum without any points. a. What are the annualized percentage all-in-costs of each alterative? b. What are the advantages and disadvantages of each alternative? c. Which alterative would you recommend? Assumptions Face amount of receivable Maturity, days Bank prime rate Spread over prime rate on credit line Bank interest (prime + spread), per annum Compensating balance requirement for bank credit line Export credit insurance fee Values 1,000,000 90 8.000% 2.500% 10.500% 20.000% 1.000% Alternative 1: Bank Credit Line Face amount of receivable Less bank interest expense on receivable Less compensating balance requirement Net proceeds 1,000,000 (26,250) (200,000) 773,750 Annualized all-in-cost of alternative 1 13.570% Alternative 2: Bank Credit Line +Export Credit Insurance Face amount of receivable Less credit insurance fee Less bank interest expense on receivable Less compensating balance requirement Net proceeds 1,000,000 (10,000) (20,000) (200,000) 770,000 Annualized all-in-cost of alternative 2 15.584% Note: The reason the compensating balance is deducted from net proceeds is that BollyIndia Enterprises does not get that cash and does not eam interest on it. Problem 16.7 Bolly India Enterprises (A) BollyIndia Enterprises has sold a combination of films and DVDs to Brazilia Media Incorporated for 1,000,000, with payment due in 3 months. BollyIndia Enterprises has the following alternatives for financing this receivable: (1) Use its bank credit line. Interest would be at the prime rate of 8% plus 250 basis points per annum. BollyIndia Enterprises would need to maintain a compensating balance of 20% of the loan's face amount. No interest will be paid on the compensating balance by the bank. (2) Use its bank credit line but purchase export credit insurance for a 1% fee. Because of the reduced risk, the bank interest rate would be reduced to 5% per annum without any points. a. What are the annualized percentage all-in-costs of each alterative? b. What are the advantages and disadvantages of each alternative? c. Which alterative would you recommend? Assumptions Face amount of receivable Maturity, days Bank prime rate Spread over prime rate on credit line Bank interest (prime + spread), per annum Compensating balance requirement for bank credit line Export credit insurance fee Values 1,000,000 90 8.000% 2.500% 10.500% 20.000% 1.000% Alternative 1: Bank Credit Line Face amount of receivable Less bank interest expense on receivable Less compensating balance requirement Net proceeds 1,000,000 (26,250) (200,000) 773,750 Annualized all-in-cost of alternative 1 13.570% Alternative 2: Bank Credit Line +Export Credit Insurance Face amount of receivable Less credit insurance fee Less bank interest expense on receivable Less compensating balance requirement Net proceeds 1,000,000 (10,000) (20,000) (200,000) 770,000 Annualized all-in-cost of alternative 2 15.584% Note: The reason the compensating balance is deducted from net proceeds is that BollyIndia Enterprises does not get that cash and does not eam interest on it
