Cash discounts should be given up only when a firm in

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Unformatted text preview: of Table 15.2. Credit terms may differ with respect to the credit period, cash discount, cash discount period, and beginning of the credit period. The cost of giving up cash discounts is a factor in deciding whether to take or give up a cash discount. Cash discounts should be given up only when a firm in need of short-term funds must pay an interest rate on borrowing that is greater than the cost of giving up the cash discount. LG1 Understand the effects of stretching accounts payable on their cost, and the use of accruals. Stretching accounts payable can lower the cost of giving up a cash discount. This is because the firm can keep its money longer if it gives up the discount. Accruals, which result primarily from wage and tax obligations, are virtually free. The key features of this spontaneous liability are summarized in part I of Table 15.2. LG2 Describe the interest rates and basic types of unsecured bank sources of short-term loans. Banks are the major source of unsecured shortterm loans to businesses. The interest rate on these loans is tied to the prime rate of interest by a risk premium and may be fixed or floating. It should be evaluated by using the effective annual rate. This rate is calculated differently, depending on whether interest is paid when the loan matures or in advance. Bank loans may take the form of a single-payment note, a line of credit, or a revolving credit agreement. The key features of the various types of bank loans are summarized in part II of Table 15.2. LG3 Discuss the basic features of commercial paper and the key aspects of international short-term loans. Commercial paper is an unsecured IOU issued by firms with a high credit standing. The key features of commercial paper are summarized in part II of Table 15.2. International sales and purchases expose firms to exchange rate risk. They are larger and of longer maturity than typical transactions, and they can be financed by using a letter of credit, by borrowing in the local market, or through dollar-denominated loans from international banks....
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