Problem 16.

1 Nikken Microsystem (A) Assume Nikken Microsystems has sold

Internet servers to Telecom España for €700,000. Payment is due in 3 months and will
be made with a trade acceptance from Telecom España Acceptance. The acceptance
fee is 1.0% per annum of the face amount of the note. This acceptance will be sold at
a 4% per annum discount. What is the annualized percentage all-in-cost in euros of
this method of trade financing?

Question summary:

Face amount of sale: €700,000

Days to maturity: 3 months (90 days)
Trade acceptance fee rate: 1.0% per annum
Sale of acceptance discount rate: 4% per annum

Solutions:
The annualized percentage all-in cost in Euros of this method of trade
financing?
● Trade acceptance fee = Face amount x Acceptance Fee rate
= €700,000 x 1.0% x (90/360) = €1,750

● Discount on sale of acceptance = Face amount x Discount rate

= €700,000 x 4% x (90/360) = €7,000

● Net proceeds = Face amount - Trade acceptance fee - Discount on sale of

acceptance
= €700,000 - €1,750 - €7,000 = €691,250

● Annualized percentage all-in-cost =

Trade acceptance fee+ Discount on sale of acceptance
Net proceeds
€ 1,750+ € 7,000 360
= x x 100=5.06 %
€ 691,250 90
Problem 16.2 Nikeen Microsystems (B) Assume that Nikken Microsystems prefers to
receive U.S. dollars rather than euros for the trade transaction described in Problem 1.
It is considering two alternatives: (1) sell the acceptance for euros at once and
convert the euros immediately to U.S dollar at the spot rate of exchange of $1.00/€ or
(2) hold the euro acceptance until maturity but at the start sell the expected euro
proceeds forward for dollars at the 3-month forward rate of $1.02/€.

Question summary:

Face amount of sale: €700,000

Days to maturity: 3 months (90 days)
Trade acceptance fee rate: 1.0% per annum
Exchange spot rate ($/€): $1.00/€
Forward exchange rate, 3-months: $1.02/€.

Solution

a) What are the U.S. dollar net proceeds received at once from the discounted
trade acceptance in alternative 1?
● Trade acceptance fee = Face amount x Trade Acceptance fee rate
= €700,000 x 1.0% x (90/360) = €1,750.

● Euro proceeds = Face amount - Trade acceptance fee

= €700,000 - €1,750 = €698,250.

● The U.S dollar net proceeds = Euro proceeds x Spot exchange rate
= €698,250 x $1.00/€ = $698,250.
b) What are the U.S. dollar net proceeds received in three months in alternative
2?
● Trade acceptance fee = Face amount x Trade Acceptance fee rate x
Maturity days
360
= €700,000 x 1.0% x (90/360) = €1,750.

● Euro proceeds = Face amount - Trade acceptance fee

= €700,000 - €1,750 = €698,250.

● The U.S. dollar net proceeds perceived at the end of 90 days = Euro proceeds x
Forward exchange rate
= €698,250 x $1.02/€ = $712,215.

c) What is the break-even investment rate that would equalize the net U.S dollar
proceeds from both alternatives?

● Question a: The U.S. dollar net proceeds: S1 = $698,250.

● Question b: The U.S. dollar net proceeds perceived at the end of 90 days: S2 =
$712,215.
S2 360
● The break-even investment rate = ( −1) x
S1 Maturity date
$ 712,215 360
=( −1) x x 100=8 % per annum.
$ 698,250 90
d) Which alternative should Nikken Microsystems choose?
● In alternative 1, Nikken Microsystems sells the acceptance for euros at once and
converts the euros immediately to U.S. dollars at the spot rate of exchange. The
net U.S. dollar proceeds received at once are $691,250.

● In alternative 2, Nikken Microsystems holds the euro acceptance until maturity

 but sells the expected euro proceeds forward for dollars at the 3-month forward
rate of $1.02/€. The net U.S. dollar proceeds received in three months are
$706,965.

● Alternative 2 results in higher net U.S. dollar proceeds ($706,965) compared to

alternative 1 ($691,250).

● However, it's essential to consider other factors such as risk and liquidity.
Alternative 2 involves holding the euro acceptance until maturity, which exposes
Nikken Microsystems to exchange rate risk. If the euro weakens against the
dollar over the three-month period, the U.S. dollar proceeds received may be
lower than anticipated. Additionally, alternative 2 ties up funds until maturity,
potentially impacting liquidity.

● Given the higher net U.S. dollar proceeds and assuming that Nikken
Microsystems is comfortable with the associated risks and liquidity
considerations, alternative 2 (selling the expected euro proceeds forward for
dollars at the 3-month forward rate) may be the preferable choice.

● If Nikken Microsystems' opportunity cost of capital is 8%, it should be indifferent

financially between the two alternatives. However, selling the acceptance at
once, alternative 1, improves Nikken's liquidity and removes the debt that
otherwise would be financing the acceptance from Nikken Microsystem's balance
sheet.
Problem 16.5 Nakatomi Toyota. Nakatomi Toyota buys its cars from Toyota Motors
(U.S.), and sells them to U.S. customers. One of its customers is EcoHire, a car rental
firm that buys cars from Nakatomi Toyota at a wholesale price. The final payment is due
to Nakatomi Toyota in six months. EcoHire has bought $200,000 worth of cars from
Nakatomi, with a cash down payment of $40,000 and the balance due in six months
without any interest charged as a sales incentive. Nakatomi Toyota will have the
EcoHire receivable accepted by Alliance Acceptance for a 2% fee, and then sell it at a
3% per annum discount to Wells Fargo Bank.

Question summary:

Face amount of sale: $200,000

Days to maturity: 6 months (180 days)

Down payment: $40,000

Trade acceptance fee rate (per annum): 2%

Discount rate on sale of acceptance (per annum): 3%

Solutions:

a) What is the annualized percentage all-in cost to Nakatomi Toyota?

● The amount needs for financing after deducting the cash down payment =
Face amount - Cash down payment

= $200,000 - $40,000 = $160,000.

● Trade acceptance fee = Amount financed x Acceptance fee rate

 = $160,000 x 2% x 180/360 = $1,600.

● Discount on sale of acceptance = Face amount x Discount rate x 180/Maturity

days

= $160,000 x 3% x 180/360 = $2,400.

● Net proceeds = Amount financed - Trade acceptance fee - Discount on sale of

acceptance

= $160,000 - $1,600 - $2,400 = $156,000.

● Annualized percentage all-in-cost =

Trade acceptance fee+ Discount on sale of acceptance 360
x x 100
Net proceeds Maturity days

$ 1,600+ $ 2,400 360

= x x 100 = 5.13%
$ 156,000 180

b) What are Nakatomi’s net cash proceeds, including the cash down payment?

● Nakatomi’s net cash proceeds, including the cash down payment = Net
proceeds + Cash down payment

= $156,000 + $40,000 = $196,000.

Problem 16.7 Sunny Coast Enterprises (A). Sunny Coast Enterprises has sold a
combination of films and DVDs to Hong Kong Media Incorporated for US$100,000, with
payment due in six months. Sunny Coast Enterprises has the following alternatives for
financing this receivable: (1) Use its bank credit line. Interest would be at the prime rate
of 5% plus 150 basis points per annum. Sunny Coast Enterprises would need to
maintain a compensating balance of 20% of the loan’s face amount. No interest will
be paid on the compensating balance by the bank. (2) Use its bank credit line but
purchase export credit insurance for a 1% fee. Because of the reduced risk, the bank
interest rate would be reduced to 5% per annum without any points.

Question summary:

Face amount of payment: $100,000

Maturity, days: 6 months = 180 days

Bank prime rate: 5% per annum

Spread over prime rate on credit line: 1.5% per annum

Compensating balance requirement for bank credit line: 20%

Bank interest rate after risk being reduced: 5% per annum

Export credit insurance fee: 1%

Solutions

a) What are the annualized percentage all-in costs of each alternative?

Alternative 1: Using the bank credit line:

● The total bank interest rate = Bank prime rate + Spread overtime rate on credit
line

= 5% + 1.5% = 6.5% per annum.

● The bank's interest expense on receivable = Face amount of payment x The

total bank interest rate x Maturity days/360

= $100,000 x 6.5% x 180/360 = $3,250.

 ● The compensating balance requirement that Sunny Coast Enterprises would
need to maintain = Face amount of payment x Compensating requirement rate

= $100,000 x 20% = $20,000.

● The net proceeds of the alternative 1 = Face amount of payment - Interest

expense on receivable - Compensating balance requirement

= $100,000 - $3,250 - $20,000 = $76,750.

● The annualized percentage all-in-cost of the alternative 1 =

Bank ' s interest expense on receivable 360
x x 100
Net proceeds Maturity days

$ 3,250 360
= x x 100=8.47 %.
$ 76,750 180

Alternative 2: Using a bank credit line and credit insurance for export:

- The bank's interest expense on receivable = Face amount of payment x

Adjusted interest rate x Maturity days/360

= $100,000 x 5% x 180/360 = $2,500.

● The compensating balance requirement that Sunny Coast Enterprises would

need to maintain = Face amount of payment x Compensating requirement rate

= $100,000 x 20% = $20,000.

● The credit insurance fee for export = Face amount of payment x Credit
insurance rate

= $100,000 x 1% = $1,000.

● The net proceeds of alternative 2 = Face amount of payment - Interest expense

on receivable - Compensating balance requirement - Credit insurance fee for
 export
= $100,000 - $2,500 - $20,000 - $1,000 = $76,500.
● The annualized percentage all-in-cost of the alternative 2 =
Bank ' s interest expense on receivable 360
● x
Net proceeds Maturity days
$ 2,500+ $ 1,000 360
= x x 100=9.15 %
$ 76,500 180
b) What are the advantages and disadvantages of each alternative?
Alternative 1
Advantages - Offer flexibility if the
borrower already has
sufficient funds to meet
the compensating
balance requirement.
- No additional cost for
insurance
Disadvantages - High interest rate of
bank credit line because
there was no export
credit insurance.
- Ties up funds in the
compensating balance,
x 100
Alternative 2
- Lower interest rate for
the export receivable
because Sunny Coast
provides export credit
insurance to Hong Kong
Media, which lowers the
interest rate for that
coverage.
- Reduced risk due to
export credit insurance
coverage.
- No requirement to tie
up funds in a
compensating balance,
providing greater liquidity
and flexibility.
- Involves an additional
cost for purchasing
export credit insurance,
leading to higher
annualized all-in-cost.
 limiting liquidity and
potential investment
opportunities.

c) Which alternative would you recommend?

● Alternative A would be suggested if Hong Kong Media has good credit and
low default risks and there is no need for credit insurance. By this, choosing
option A with a compensating balance and higher interest rate is cost-effective.

● Alternative B would be suggested if Hong Kong Media has poor or uncertain

credit and high default risk. In this scenario, purchasing credit insurance
through alternative B is a prudent risk management strategy despite the
additional cost.

Problem 16.12. Swishing Shoe Company. Swishing Shoe Company of Durham,

North Carolina, has received an order for 50,000 cartons of athletic shoes from
Southampton Footware, Ltd., of England, payment to be in British pounds sterling.
The shoes will be shipped to Southampton Footware under the terms of a letter of credit
issued by a London bank on behalf of Southampton Footware. The letter of credit
specifies that the face value of the shipment, £400,000, will be paid 120 days after the
London bank accepts a draft drawn by Southampton Footwear in accordance with the
terms of the letter of credit.

The current discount rate in London on 120-day bankers’ acceptances is 12% per
annum, and Southampton Footware estimates its weighted average cost of capital to
be 18% per annum. The commission for selling a banker’s acceptance in the
discount market is 2.0% of the face amount.
Question summary:

Face amount of shipment: £400,000

Maturity, days: 120 days

Current discount rate = 12% per annum

WACC = 18% per annum

Discount bank acceptance = 2%

Solutions

a) Would Swishing Shoe Company gain by holding the acceptance to maturity, as

compared to dis-counting the bankers’ acceptance at once?

Alternative 1: Swishing Shoe Company holds the acceptance to maturity:

If Southampton Footware holds the draft for 120 days after the bank has accepted it,
Swishing Footware will receive the face amount of £400,000. The present value of
£400,000 received 120 days hence, discounted at Southampton's WACC of 18% per
annum (6% for 120 days) is:

Face amount of shipment £ 400,000

=
= (1+WACC x
Maturity days
) (1+ 18 % x
120
)
360 360

= £377,358.49.

Alternative 2: Swishing Shoe Company discounts the acceptance at once:

● The banker's acceptance discount = Face amount x Discount rate x

Maturity days
360
 120
= £400,000 x 12% x = £16,000
360

● The banker's commission fee = Face amount x Commission rate

= £400,000 x 2% = £8,000

● Net proceeds for alternative 2 = Face amount - Banker's acceptance discount -

Commission fee

= £400,000 - £16,000 - £8,000 = £376,000

Conclusion:

- Swishing's Gain = Present Value of Face Value (Alternative 1) - Net Proceeds

from Banker's Acceptance (Alternative 2)

= £377,358.49 - £376,000

= £1,358.49

In this case, Swishing would gain approximately £1,358.49 in terms of present value cash by
waiting 120 days to receive the face amount of the acceptance.

b) Does Swishing Shoe Company incur any other risks in this transaction?
Since the payment from Southampton Footware is in British pounds sterling (GBP),
Swishing Shoe Company is exposed to foreign exchange risk. Fluctuations in the
GBP/USD exchange rate between the time of the order and the receipt of payment can
impact the actual value of the payment in US dollars. To be more specific, if the
expected exchange rate decreases, Swishing Shoe Company may face a loss since
the company waits until maturity without securing a forward contract for exchange.
Conversely, given the exchange rate increases, the company will gain.