By NDH 1

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

By NDH 08/24/2013
3 Bank financing
Bank lines of credit
Invoice discounting
Factoring
Forfaiting
Leasing

By NDH 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 firm’s 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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 Invoice discounting
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 Percentage discount

 Interest rate

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 Invoice discounting
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 Accepted drafts

 Invoice discounting facility:

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 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 Distiller’s
bankers’ acceptance for a discount of 6% per annum.
What should the beer exporter do?
By NDH 08/24/2013
 Example 2
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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?
b. What are Cutler Toyota’s net cash proceeds, including the cash
down payment?

By NDH 08/24/2013
 Factoring
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 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
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 Factoring: More than financing
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 Factoring: Pros and cons
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 Example
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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 loan’s 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 alternative?
b. What are the advantages and disadvantages of each alternative?
c. Which alternative would you recommend?
By NDH 08/24/2013
 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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 Forfatiting
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 Forfaiting is like factoring for medium-to-long

term receivables and without recourse

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 Forfaiting: Procedure
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 Example
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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.
a. What is the annualized percentage all-in-cost to Unicorn Drilling of financing the
first $200,000 note due March 1, 2004?
b. What might motivate Unicorn Drilling to use this relatively expensive alternative
for financing? By NDH 08/24/2013
19 Direct financing

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 Euro note facilities
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 Short-term instruments issued directly to the

market and underwritten by banks

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 Euro commercial paper
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 Short-term instruments issued directly to the

market but non-underwritten.

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 Euro note market
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 Euro medium-term note:

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23 Commercial credit
Supplier credit
Buyer credit
Counter trade

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 Supplier credit
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 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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 Supplier credit
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 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
company’s perceived creditworthiness

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 Common credit terms
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 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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 Example
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1. What is the cost of credit to buyer for a term of

credit specifying 2/10 net 60
2. 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:
1. 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

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 Documented supplier credit over
Open account
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 Counter trade
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 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

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 Types of countertrade
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 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 addition of a clearing agreement to a barter scheme allows
for a time lag between barter components. Thus credit facilitates
eventual matching of the transactions.
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 Types of countertrade
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 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.

By NDH 08/24/2013
 Types of countertrade
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 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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 Types of countertrade
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 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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34

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35
Government-supported
financing
Export credit insurance
Export financing

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 Forms of insurance
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 Exporter policies:

 Lender policies:

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 Who gives the insurance
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 Private insurer:
 Government-supported insurance schemes:

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 Risk covered
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 Commercial risk

 Political risk:

By NDH 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 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 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 A’s bank. Firm A’s bank requires a fee of 1%, deposit of
20% over the life of guarantee and applies a 2% interest on the deposit.
2. Firm B’s bank agrees to issue L/C payable in 6 months upon following
conditions:
 No deposit required, however firm B’s 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%
interest rate and 1% fee.
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 Win-win negotiation
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 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