By NDH

FINANCING
ALTERNATIVES
08/24/2013

By Nguyen Diep Ha

Principles
2

Consider both explicit and implicit costs

For explicit costs and payments:
establish the net cash flows then
calculate the NPV of payments received
or paid
Sometimes, IRR is preferred if an
appropriate discount rate is not likely to
be established

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08/24/2013

Bank financing
Bank lines of credit
Invoice discounting
Factoring
Forfaiting
Leasing

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08/24/2013

Bank credit
4

Often based on current account and its overdraft

facility, backed by general collateral pledged to the
bank.

The cost of using a bank credit line is usually the

prime rate of interest plus a premium to reflect the
firms credit risk

By NDH

08/24/2013

Example
5

A bank loan of $600,000 is to be disbursed into

3 equal payments from 2004 to 2006 and
returned over a 4-years schedule as following:
80,000 in 2009, 120000 in 2010, 160000 in
2011 and the remaining in 2012.
Interest rate applied : 4%
A commission for broker of 0.5% paid upfront
Processing fee: 0.15% paid upfront
A deposit of 20% of loan amount is required at
all time over the life of the loan on which the
bank will pay 0.25%
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08/24/2013

Invoice discounting
6

Percentage discount

Interest rate

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08/24/2013

Invoice discounting
7

Accepted drafts

Invoice discounting facility:

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08/24/2013

Example
8

Wisconsin Distillers exports beer to Australia and

invoices its customers inU.S. dollars. Sydney
Wholesale Imports has purchased $1,000,000
of beer from Wisconsin Distillers, with payment
due in six months. The payment will be made
with a bankers acceptance issued by Charter
Bank of Sydney at a fee of 1.75%per annum.
Wisconsin Distillers has a weighted average
cost of capital of 10%. Bank of America is
willing to buy Wisconsin Distillers bankers
acceptance for a discount of 6% per annum.
What should the beer exporter do?
By NDH

08/24/2013

Example 2
9

Cutler Toyota buys its cars from Toyota Motors-USA, and

sells them to U.S. customers. One of its customers is
Green Transport, a car rental firm that buys cars from
Cutler Toyota at a wholesale price. Final payment is due
to Cutler Toyota in six months. Green Transport has
bought $200,000 worth of cars from Cutler, with a cash
down payment of $40,000 and the balance due in six
months without any interest charged as a sales
incentive.
Cutler Toyota will have the Green Transport receivable
accepted for a 2% fee, and then sell it at a 3% per
annum discount to Wells Fargo Bank.
a. What is the annualized percentage all-in-cost to
Cutler Toyota?
By NDH 08/24/2013
b. What are Cutler Toyotas net
cash proceeds,

Factoring
10

Factoring is a special form of short-term

finance where the seller entering into a
factoring agreement sells the
receivables to the factor, mostly also
relieving themselves of the credit
control and debt collection
functions, which are assumed by the
factor against a fee.

By NDH

08/24/2013

Factoring: How it works

11

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08/24/2013

12

Factoring: More than

financing

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08/24/2013

Factoring: Pros and cons

13

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08/24/2013

Example
14

Hollywood Entertainment has sold a combination of films and

DVDs to Hong Kong Media Incorporated for US$100,000, with
payment due in six months.
Hollywood Entertainment 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. Hollywood
Enterprises would need to maintain a compensating
balance of 20% of the loans face amount. No interest will
be paid on the compensating balance by the bank.
(2)
Use factoring service from a factor that offers to purchase
the Hong Kong Media Imports receivable at a 16% per
annum discount plus a 2% charge for a nonrecourse
clause.
a. What are the annualized percentage all-in-costs of each
By NDH 08/24/2013
alternative?

Example
15

Hanoi Tech, an IT company based in Hanoi, is

considering using factoring for its exporting
receivable. The factor requires a factoring fee of
2% per annum and agrees to release 80% of
receivable amount due in 6 months. It also applies
an interest rate of 12% on VND and 4.5% on USD.
The current spot rate is VND20000/$
The 6-month forward rate is VND20500/$
The expected spot rate in 6-month is VND20800/$
What denomination should Hanoi Tech choose?

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08/24/2013

Forfatiting
16

Forfaiting is like factoring for medium-tolong term receivables and without

recourse

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08/24/2013

Forfaiting: Procedure
17

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08/24/2013

Example
18

Kaduna Oil of Nigeria has purchased $1,000,000 of oil drilling

equipment from Unicorn Drilling of Houston, Texas, payable over
the next five years at a rate of $200,000 per year due on March 1
of each year.
Bank of Zurich, a Swiss forfaiter, has agreed to buy the five notes of
$200,000 each at a discount. The discount rate would be
approximately 8% per annum based on the expected three-year
LIBOR rate plus 200 basis points. Bank of Zurich also would
charge Unicorn Drilling an additional commitment fee of 2% per
annum from the date of its commitment to finance until receipt of
the actual discounted notes issued in accordance with the
financing contract. The $200,000 promissory notes will come due
on March 1 in successive years.
The promissory notes issued by Kaduna Oil will be guaranteed by
their bank, Lagos City Bank, for a 1% fee and delivered to Unicorn
Drilling. At this point Unicorn Drilling will endorse the notes
without recourse and discount them with the forfaiter, Bank of
Zurich.
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08/24/2013

19

Direct financing

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08/24/2013

Euro note facilities

20

Short-term instruments issued directly to

the market and underwritten by banks

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Euro commercial paper

21

Short-term instruments issued directly to

the market but non-underwritten.

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08/24/2013

Euro note market

22

Euro medium-term note:

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23

Commercial credit
Supplier credit
Buyer credit
Counter trade

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08/24/2013

Supplier credit
24

From the perspective of seller

The possibility of the seller agreeing to a

supplier credit is determined by how it can
be refinanced, the risks involved
A sale arguments: Stricter credit criteria will
discourage sale, while lighter conditions
may increase sale at the cost of longer
credit term and higher possibility of bad
accounts

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08/24/2013

Supplier credit
25

From the perspective of buyer

The economics of taking trade discount:

Paying too early is costly because cash is
used unnecessarily and interest is
sacrificed while paying late can damage the
companys perceived creditworthiness

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08/24/2013

Common credit terms

26

Ordinary terms: (1) Net t: refer to the length of time a customer

has to pay the invoice before becoming past due. (2) d/t1 net t2:
t1 is the time period for a discount of d%, t2 is the length of time a
customer has to pay the invoice before becoming past
Cash before delivery (CBD): require that the amount of the
invoice must be paid in advance before delivery will be scheduled
Cash on delivery (COD): require that payment must be made
when the product is delivered
Bill-to-bill: require that each prior bill must be paid before new
shipments are possible
Monthly billing: require payment monthly. Format: d/t1th Prox
net t2th. E.g.:2/10th prox net 30th means that the customer can
take a 2% discount if it pays within the first 10 days of the next
month or else it must pay the full amount of the invoice by the
30th day of the next month.

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08/24/2013

Example
27

1.

2.

What is the cost of credit to buyer for a term of

credit specifying 2/10 net 60
Firm A of Vietnam sells coal to a Firm B of China
on a regular basis. The two agrees to use open
account payable semiannually. For the period
of 1/2010 to 6/2010, there are 2 shipments:
1000 MT of coal shipped on 20/2/2010 at
245RMB/MT
2. 2000 MT of coal shipped on 15/5/2010 at
240RMB/MT
The market price for this type of coal is at
235RMB/MT. What is the cost of financing to buyer?a
1.

By NDH

08/24/2013

Documented supplier credit over

Open account
28

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08/24/2013

Counter trade
29

The word countertrade refers to a variety of

international trade arrangements in which an
export sale is tied/compensated by contract to an
import.
Conventional wisdom: countertrade takes place
with

Empirical evidence: countertrade takes place

with
By NDH

08/24/2013

Types of countertrade
30

Transactions that avoid the use of money include:

Simple barter. Simple barter is a direct exchange of

physical goods between two parties. It is a one-time
transaction carried out under a single contract that
specfies both the goods to be delivered and the goods to
be received at the same time, and no money is
exchanged. Money may, however, be used as the
numeraire by which the two values are established and
the quantities of each good are determined.

Clearing arrangements. In a clearing arrangement,

each party agrees to purchase a specific (usually equal)
value of goods and services from the other, with the cost
of the transactions debited to a special account. At the
end of the trading period, any residual imbalances may
be cleared by shipping additional goods or by a hard
currency payment. In effect, the
of a clearing
By addition
NDH 08/24/2013

Types of countertrade
31

Switch trading. Switch trading involves

transferring use of bilateral balances from one
country to another. For example, an original
export from Canada to Romania is paid for with
a balance deposited in a clearing account in
Romania. Although the clearing account might
be measured in Canadian dollars or any other
currency, the balance can be used only to
purchase goods from Romania. The original
Canadian exporter might sell the clearing
balance at a discount to a switch trader, who
in turn purchases goods from Romania.
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08/24/2013

Types of countertrade
32

Transactions that use money or credit but

impose reciprocal commitments

Buyback or compensation agreement. A

compensation agreement, also called a
buyback transaction, is an agreement by an
exporter of plant or equipment to take
compensation in the form of future output from
that plant. Such an arrangement has attributes
that make it, in effect, an alternative form of
direct investment. The value of the goods
received usually exceeds the value of the
original sale, as would be appropriate to reflect
the time value of money.
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08/24/2013

Types of countertrade
33

Counterpurchase. A counterpurchase involves an

initial export, but with the exporter receiving
merchandise that is unrelated to items the exporter
manufactures. A widely publicized early example was the
export of jet aircraft by McDonnell Douglas to Yugoslavia
with payment partly in cash and partly in Zagreb hams,
wines, dehydrated vegetables, and even some power
transmission towers designated eventually for the city of
Los Angeles. McDonnell Douglas had the responsibility
for reselling the goods received.
Offset. Offset refers to the requirement of importing
countries that their purchase price be offset in some way
by the seller. The exporter may be required to source
some of the production locally, to increase imports from
the importing country, or to transfer technology.
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08/24/2013

34

By NDH

08/24/2013

35

Government-supported
financing
Export credit insurance
Export financing

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08/24/2013

Forms of insurance
36

Exporter policies:

Lender policies:

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08/24/2013

Who gives the insurance

37

Private insurer:
Government-supported insurance
schemes:

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08/24/2013

Risk covered
38

Commercial risk

Political risk:

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08/24/2013

Example
39

Hollywood Entertainment has sold a combination of films and

DVDs to Hong Kong Media Incorporated for US$100,000, with
payment due in six months. Hollywood Entertainment 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. Hollywood Enterprises
would need to maintain a compensating balance of 20% of the
loans 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 and
there will be no need to maintain a 20% balance.
Which alternative would you recommend?
By NDH

08/24/2013

Win-win negotiation
40

Firm A of Vietnam sells $500,000 of rice to Firm B in the US. Two

firms are negotiating the terms of payment, considering 3
alternatives:
1. Firm B pay in advance 100% of contract value 2 months before
shipment date in return for a 2% discount. Also, firm A has to
present advance payment guarantee from firm As bank. Firm As
bank requires a fee of 1%, deposit of 20% over the life of
guarantee and applies a 2% interest on the deposit.
2. Firm Bs bank agrees to issue L/C payable in 6 months upon
following conditions:
No deposit required, however firm Bs credit lines reduce by $500,000

Issuing fee: 1%, acceptance fee: $500 and advising fee: $60
All the fees, except for advising fee, are born by firm B. Firm A can sell this
bank acceptance later on in the market for a discount of 6% per annum.

3.

Firm B pays in 6 months however firm A can buy export credit

insurance at 1% fee for their receivable and sell it to a factor on a
non-recourse basis. The factor agrees to pay 90% of invoice value
in advance and applies a 5% interestBy
rate
1% fee.
NDHand
08/24/2013

Win-win negotiation
41

What is the best alternative from the

perspective of firm A?
What is the best alternative from the
perspective of firm B?
What is the best alternative from the
perspective of the two firms?
Do you suggest a better combination
than all 3 alternatives given the
information provided.
By NDH

08/24/2013