Current Asset

Management and Short-

Term Financing

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INTERNATIONAL CASH
MANAGEMENT
I. INTERNATIONAL CASH MANAGEMENT
A. Seven Key Areas Involve Issues about
1. Organization
2. Collection/Fund Disbursement
3. Interaffiliate Payments
4. Investment of Excess Funds
5. Optimal Global Cash Balances
6. Bank Relations

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 INTERNATIONAL CASH
MANAGEMENT
B. Goals of an International Cash
Manager: similar to domestic
manager
1. Quick and efficient cash control
2. Optimal conservation and usage
response

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INTERNATIONAL CASH
MANAGEMENT
Issue (1): Centralize
Organization
1. Advantages:
a. Efficient liquidity levels
b. Enhanced profitability
c. Quicker headquarter

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INTERNATIONAL CASH
MANAGEMENT
1. Advantages (cont)
d. Decision making enhanced
e. Better volume currency quotes
f. Greater cash management
expertise
g. Less political risk

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INTERNATIONAL CASH
MANAGEMENT
Issue (2): Collection/Disbursement
of Funds
1. Key Element: Accelerate collections
2. Acceleration Methods:
a. Electronic fund transfers
b. Mobilization centers

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INTERNATIONAL CASH
MANAGEMENT
3. Methods to Expedite Cash Payments
a. Wire cash transfers
b. Establish accounts in clients bank
c. Negotiate with banks
- obtain value dating

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INTERNATIONAL CASH
MANAGEMENT
Issue (3): Interaffiliate Payments
Use Payments Netting
1. Definition:
offset payments of affiliate receivables/payables
net amounts only are transferred.

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INTERNATIONAL CASH
MANAGEMENT
2. Create Netting Center
a. set up a subsidiary in a location
with minimal exchange controls
b. Coordinate interaffiliate payment
flows
c. Netting Centers value:
a direct function of the volume of
transfers.

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INTERNATIONAL CASH
MANAGEMENT
Issue (4): Excess Funds Investment
1. Major task:
a. determine minimum cash
balances
b. short-term investment of
excess balances

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INTERNATIONAL CASH
MANAGEMENT
2. Requirements:
a. Forecast of cash needs
b. Knowledge of minimum
cash position

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INTERNATIONAL CASH
MANAGEMENT
3. Investment Selection
Criteria:
a. Degree of Government
regulations
b. Market structure
c. Leniency of Foreign tax
laws

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INTERNATIONAL CASH
MANAGEMENT
Issue (5) Optimal Global Cash
Balances
1. Establish centrally managed cash
pool
2. Require affiliates to hold minimum
amounts

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INTERNATIONAL CASH
MANAGEMENT

3. Benefits of Optimal Global Cash

Balances
a. Less outside borrowing needed
b. More excess fund for investment
c. Reduced internal expense
d. Reduced currency exposure

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INTERNATIONAL CASH
MANAGEMENT
Issue (6) Bank Relations
1. Good Relations Will Avoid
a. Lost interest income
b. Overpriced services
c. Redundant services

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INTERNATIONAL CASH
MANAGEMENT
2. Common Bank Relations Problems
a. Too many banks
b. High costs
such as compensating
balances
c. Inadequate reporting
d. Excessive clearing delays

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ACCOUNTS RECEIVABLE
MANAGEMENT
II. ACCOUNTS RECEIVABLE MANAGEMENT
A. Trade Credits
extended in anticipation of profit by
1. expanded sales volume
2. retaining existing customers

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ACCOUNTS RECEIVABLE
MANAGEMENT
B.Credit Terms Should Consider
1. Sales force
customer selection criteria
2. Adjusting sales bonuses for cost
of credit sales.

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INVENTORY MANAGEMENT
III. INVENTORY MANAGEMENT
A. Problems:
MNCs seem to have more
difficulties due to
1. Long,variable transits

2. Lengthy customs procedures

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INVENTORY MANAGEMENT
B.Issue: Production Location
1. Overseas location may lead to
higher inventory carrying costs
due to
a. larger amounts of work-in-
process
b. more finished goods
2. Why?

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INVENTORY MANAGEMENT
C. Subsidiary Practice known as:

Advanced Inventory Purchases

OR

inventory stockpiling.

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INVENTORY MANAGEMENT
D. Reason for Stockpiling:
- reduce risk of shipping delays

E. Results of Stockpiling:
- Higher carrying costs

F. Solution to higher carrying costs:

- Adjust affiliates profit margins to reflect added
costs.

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PART 2
Short-Term Financing

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SHORT-TERM FINANCING
IV. SHORT-TERM FINANCING
A. Strategy
1. Identify: 3 key factors
2. Formulate/evaluate:
objectives
3. Describe: available options
4. Develop a methodology:
to calculate/compare costs EIR

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SHORT-TERM FINANCING
B. Key Factors
1. Deviations from Intl Fisher Effect?
a. If yes
- trade-off required between cost and
exchange risk
b. If no
- costs are same everywhere

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SHORT-TERM FINANCING
2. Does Interest Rate Parity Hold?
a. Yes. Currency is irrelevant.
b. No. Cover costs may differ
-added risk may mean the forward
premium/discount does not offset
interest rate differentials.

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SHORT-TERM FINANCING
3. Political Risk: If high,
a. MNCs should
1.) maximize local
financing.
2.) Faced with confiscation
or currency controls,
fewer assets at risk

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SHORT-TERM FINANCING
OBJECTIVES
C. Short-Term Financing Objectives

1. Possible Objectives:
a. Minimize expected cost.
b. Minimize risk without regard
to cost.

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SHORT-TERM FINANCING
OBJECTIVES
D. Short-Term Financing Options
1. Two Major Possibilities
a. Inter-company loans
b. Local currency loans

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SHORT-TERM FINANCING
OBJECTIVES
2. Local Currency Financing: Bank Loans
a. Short-term in nature
What is the role of cleanup clause?
b. Forms of Local Currency bank loans
1.) Term loans
2.) Line of credit
3.) Discounting

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EFFECTIVE INTEREST RATE

3. Calculating Interest Costs

a. Effective interest rate (EIR):
- most efficient measure
of cost
b. Basic formula:
EIR = Annual Interest Paid
Funds Received

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EFFECTIVE INTEREST RATE
Sample Problem 1 Simple Interest
Pro Logic Co. receives a loan for $10,000 at
11% interest payable at maturity at the end of
one year. What is the EIR?

EIR = $1,100 (10,000x.11)

$10,000 10,000
= 11%

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EFFECTIVE INTEREST RATE
Sample Problem 2 Discounting the loan
Pro Logic Co. receives a loan for $10,000 at 11% on
a discounted basis for one year. What is the EIR?

EIR = $1,100 (10,000x.11)

$8,900 10,000-1100
= 1100
8900
= 12.4%

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EFFECTIVE INTEREST RATE
Sample Problem 3: Compensating Balances
Pro Logic Co. receives a loan for $10,000 at 11%
with a 15% compensating balance requirement for
one year. What is the EIR?

EIR = $1,100 (10,000x.11)

$8,500 10,000-1500
= 1100
8500
= 12.9%

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EFFECTIVE INTEREST RATE
Sample Problem 4: Compensating Balance on
a discounted loan
Pro Logic Co. receives a loan for $10,000 at 11% on
a discounted basis and a 15% compensating balance
requirement for one year. What is the EIR?

EIR = $1,100 (10,000x.11)

$7,400 10,000-1100-1500
= 14.9%

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COMMERCIAL PAPER
4. Non-bank lending : Commercial Paper
a. Definition:
short-term unsecured promissory
note generally sold by large MNCs
on a discount basis.
b. Standard maturities
c. Bank fees charged for:
1.) Backup line of credit
2.) Credit rating service

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Evaluating Borrowing Abroad vs
Borrowing at Home
Formula:
C = change
% change depreciate/appreciate of foreign
currency in local currency
c = e1 e0
e0
Before tax cost of borrowing abroad
= Rfc (1-c) - c

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Evaluating Borrowing Abroad vs
Borrowing at Home
Formula:

After tax cost of borrowing abroad/foreign

currency
CHFC = Rfc ( 1 - c )( 1 t ) c

After tax cost of borrowing local/home currency

CHC = Rhc ( 1 t ) - ct

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Evaluating Borrowing Abroad vs
Borrowing at Home
Breakeven / Indifferent
1 + Rhc = e1
1 + Rfc e0
@
c* = Rfc Rhc x 100
1 + Rfc
c = c*
c > c* = cheaper to borrow in FC
c < c* = cheaper to borrow in HC
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Evaluating Borrowing Abroad vs
Borrowing at Home
Example 1:
Multinational Corp always face alternative financing
decisions on whether to borrow at home or abroad.
Suppose a US firm located in Brazil needs to decide
if they should borrow for a year in US (USD) or Brazil
(Real). The following information is available:
US interest rate : 3.75% per annum
Brazil interest rate : 3.5% per annum
Spot Exchange rate : BR2.2828/US$
Expected Future Spot rate : BR2.2586/US$

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Contd Example
a) Calculate the expected after tax real cost of
the Brazilian real loan if the Brazilian
corporate tax rate is 28%.
b) Explain whether it is cheaper to borrow in
Brazil or in the US? Prove decision by
calculations.
c) Find the year end exchange rate that makes
borrowing in the US and Brazil indifferent.

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 Example 2:
Prolon (Malaysia) could borrow ringgit at 4%
or dollars at 6% for one year. The
USD:Ringgit exchange is expected to move
from RM3.4240/USD currently to
RM3.3500/USD by the year end. Chevrolet is
paying 35% corporate tax.
i) What is the before tax home currency
equivalent cost?

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 ii) What is the after tax ringgit cost of dollar
loan?
iii) What is the after tax ringgit cost of ringgit
loan?
iv) Which currency loan has the lowest after
tax cost?

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 Example 3:
A US firm, with a subsidiary in Malaysia is in
need of RM100m for one year to finance its
operations in KL. It has the option to borrow
locally thru a bank loan which charges annual
int of 4.5% above BLR. The current BLR is
3.5%. The bank loan also requires a 5%
compensating balance on the loan amount.

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 In the mean time, the firm is also
contemplation to borrow home currency
(US$) which charges an annual interest of
5.5%. The current exchange rate is
RM3.2110/US$ and this rate is expected to
appreciate to RM3.2245/US$ in one years
time. (assume tax rate is 28%)
i) Determine the effective rate of loan
borrowing in Malaysia.
ii) Determine the after tax dollar cost of
borrowing ringgit. 45
 iii) Determine after tax dollar cost of
borrowing dollar.
iv) Which option should this firm
undertake?Why?

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 Example 4:
Landmark, a Msian company located in
London is deciding to borrow either ringgit or
pound sterling for maturity of one year. The
exchange rate is currently at RM6.4454/GBP
and expected to move to RM6.4300/GBP by
the end of the year.
The interest rate in Malaysia is 3.5% and in
London is 5%. The corporate tax rate in
London is 35%.
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 i) At what exchange rate would the company
be indifferent b/w Msia and London?
ii) What is the before tax ringgit cost of pound
loan?
iii) What is the after tax ringgit cost of pound
loan?
iv) What is the after tax ringgit cost of ringgit
loan?
v) In which currency would you suggest the
company borrows?
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