Cash Management

Neney

Hi everyone, I am new to this forum. I have question about how you would calculate the figures for 2.4 in the Cash Management Exam.



Task 2.4

The three partner firm of Parry & Associates is planning to expand its production facilities. The expansion plans will require the purchase of new machinery at a cost of £78,000 and a working capital injection of £18,000.

The partnership has been seeking possible means of funding the expansion and has been offered three options:

Option 1 A bank loan of £78,000 secured on the new machinery. Capital repayments are to be made over four years in equal instalments. The interest rate is fixed at 6% per annum calculated on the capital balance outstanding at the beginning of each year.

An arrangement equal to 1% of the bank loan is payable at the beginning of the loan term.

The bank is also offering an overdraft facility of £19,500 which attracts an annual interest rate of 12%. The partners believe that they will require an average overdraft of £16,000 for eight months of the first year.

Option 2 A bank loan of £96,000 secured on the assets of the partnership. Principle (capital) repayments are to be made over four years, with a four month payment holiday at the beginning of the loan term. (This means that repayments of the principle will not begin until the fifth month after the loan is received by the partnership.)

The interest rate is fixed at 6½% per annum for the first two years and will then revert to a variable interest rate set at 3% above the base rate.

An arrangement fee equal to 0.75% of the bank loan is payable at the beginning of the loan term.

Under this option there will be no requirement for a bank overdraft facility.

Option 3 Each of the three partners will take out a personal secured loan of £32,000 repayable over five years at an interest rate of 2.5%. These monies will then be loaned to the partnership as increased capital. Interest of 4% per annum is payable by the partnership to the partners.

Under this option there will be no requirement for a bank overdraft facility.

An extract from the partnership policy in respect of raising finance states the following:

• The maximum overdraft facility that the partnership may obtain is £20,000.
• Interest payable by the partnership is to be kept as low as possible.
• Loan finance may be secured on the assets of the partnership.
• The partners should not give personal guarantees or security for loan finance.

(a) Complete the table below to calculate the cost to the partnership for the first year of financing under each of the three options:

Loan interest
£ Arrangement fee
£ Overdraft interest
£ Total cost
£
Option 1
Option 2
Option 3

(b) Which financing option should the partnership select taking account of the provision of the partnership policy? (Tick one)

Option 1
Option 2
Option 3
None of the options

I would be grateful if anyone could let me calculation. I have an exam on Tuesday and this is the only qustion I don't get and an't do either

Thank you.

Jo Clark

Hello Neney

You need to complete the calculations for each of the options listed to ascertain the loan interest, arrangement fee and overdraft interest. For example, Option 1 A bank loan of £78,000 secured on the new machinery. Capital repayments are to be made over four years in equal instalments. The interest rate is fixed at 6% per annum calculated on the capital balance outstanding at the beginning of each year.

An arrangement equal to 1% of the bank loan is payable at the beginning of the loan term.

The bank is also offering an overdraft facility of £19,500 which attracts an annual interest rate of 12%. The partners believe that they will require an average overdraft of £16,000 for eight months of the first year.

You need to calculate:

loan interest 6% of £78,000 = £4,680
arrangement fee 1% of £78,000 = £780
overdraft facility 12% of £16,000 = £1,920 however it is only for eight months so £1,920/12*8 = £1,280
total cost for option 1: £4,680 + £780 + £1,280 = £6,740

Complete this process for option 2 and 3.

You then need to take into account the partnership policy in respect of raising finance (as detailed in the question). The extract from the partnership policy in respect of raising finance states the following:

• The maximum overdraft facility that the partnership may obtain is £20,000.
• Interest payable by the partnership is to be kept as low as possible.
• Loan finance may be secured on the assets of the partnership.
• The partners should not give personal guarantees or security for loan finance.

Therefore, having completed the calculations for the three options, the second part of the question about which financing option should the partnership select taking account of the provision of the partnership policy should be fairly straightforward to answer. I won't answer it so you can look yourself.

Feel free to post your answer here and if you get stuck on it I'll try and help you further.

Good luck!

JC

Neney

Hello JC,

Thanks for this. I will try and do the question.

Neney