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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)
80% x 4,000,000 x18% x 6
% cost of discount =
100 2% 40 10
Cost of foregone discount
This question was answered on: Feb 21, 2020
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