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# Cost of Bank Loans

1. Simple Interest
2. Discount interest
4. Simple Interest with Compensating Balance
5. Discount Interest with Compensating Balance
SIMPLE INTEREST
In a single interest loan, the borrower receives
the face value of the loan and repays the principal
and interest at maturity date.

## Formula to compute the effective interest rate is:

Interest
Effective annual rate simple =
Face Value Interest
Compute the effective annual interest rate for a one-year loan
of P200,000 at 10% annual interest per year payable at
maturity.
P20,000
Effective annual rate simple =
P200,000

## *Simple interest loan of 1 year or more: nominal rate = effective rate

If the loan had a term of less than 1 year, say 90 days, the
effective annual rate would be calculated as follows:
Secured Short Term Financing

## 1. Pledging of Accounts Receivable

2. Factoring of Accounts Receivable
3. Inventory Loans with
a. floating of blanket lien
b. chattel mortgage
c. field warehouse financing agreement
d. terminal warehouse receipt
Pledging Accounts Receivable
The borrower simply pledges or assigns accounts
receivable as a security for a loan obtained from either
a commercial bank or finance company.

## All AR are pledged 75% and below

Selected AR are pledged up to 85% or 90%
The XYZ Company sells plumbing supplies to building contractors on
terms of net 60. The firms average monthly sales are 100,000; thus its
average accounts receivable balance is 200,000, based on the two months
credit period. The company pledges all its receivables to a local bank,
which in turn advances up to 70% of the face value of the receivables at
3% over prime and with a 1% processing charge on all receivables
pledged. XYZ Company follows a practice of borrowing the maximum
amount possible. The current prime rate is 12%.
What is the effective cost of using this source of financing for a full
year?
The effective cost of this loan is computed as follows:
(P200,000 x 70% x 15%) + 1% x P100,000 x 12 mos. 1
Effective annual rate = x
70% x P200,000 360

## P21,000 + P12,000 1 360

= x
P140,000 360
360
In the preceding example, XYZ Company may save credit
department expenses of P15,000 per year by pledging all its
accounts and letting the lender provide those services.

## P21,000 + P12,000 - P15,000 1

Effective annual rate = x
P140,000 360
P18,000 1 360
= x
P140,000 360
360

## * Advantage of Pledging Flexibility

**Disadvantage of Pledging Cost
Basic Concepts
Financial structure is the mix of all assets which appear
on the right hand side of the companys statement of financial
position while Capital structure pertains to the mix of long-
term sources of funds.

## Financial Structure design necessitates consideration of the

following issues:
1) What should be the maturity composition of the firms
sources of funds?
2) What should be the proportion of the various forms of
financing to be utilized to the total financing required?
Basic Tools of Capital Structure Management

## Capital can come from debt or equity.

The use of debt tends to increase earnings per
share which lead to a higher stock price.
The use of debt also increases the risk borne by
shareholders, which lowers the stock price.
If the actual debt ratio is below the target level,
expansion capital will probably be raised by
issuing debt.
If the debt ratio is above the target, equity will
probably be used.