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(a) The Chuma Ngumu Company needs to finance a seasonal rise in

(a)         The Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh.4 million.  The funds are needed for six months.  The company is considering using the following possibilities to finance the inventories:

1.          A warehouse loan from a finance company.  The terms are 18 per cent annualized with an 80% advance against the value of the inventory.  The warehousing costs are Sh.350,000 for the six-month period.  The residual financing requirement which is Sh.4 million less the amount advanced will need to be financed by forgoing cash discounts on its payables.  Standard terms are 2/10 net 30: however the company feels it can postpone payment until the fortieth day without adverse effect.

2.          A floating lien arrangement from the supplier of the inventory at an effective interest rate of 24 per cent.  The supplier will advance the full value of the inventory.

3.          A bank loan from the company?s bank for Sh.4 million.  The bank can lend at the rate of 22%.  In addition, a 10% compensating balance will be required which otherwise would not be maintained by the company.


            Which is the cheapest option for the company?                                                   (15 marks)

Financing options





Warehouse loan


Warehousing costs





80% x 4,000,000 x18% x 6



% cost of discount =
















100 2% 40 10



Cost of foregone discount







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