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CMA Intermediate · Financial Management and Business Data Analytics · Introduction to Working Capital Management

Mahalakshmi Ltd needs ₹9,00,000 net cash for 90 days. A bank offers a loan at 12% p.a. with interest deducted in advance (discounted) for the 90 days. Using a 360-day year, the face amount of loan that must be borrowed to receive ₹9,00,000 net, and the effective annual rate, are closest to:

The firm must borrow about ₹9,27,835 and the effective rate is about 12.37%. Since 3% interest is deducted upfront for 90 days, net proceeds are 97% of face value. Dividing 9,00,000 by 0.97 gives the face amount, and 3/97 multiplied by four gives the annual cost.

  1. A₹9,27,835 and 12.37%Correct
  2. B₹9,27,835 and 12.00%
  3. C₹9,00,000 and 12.37%
  4. D₹9,30,000 and 12.37%

Explanation

Interest for 90 days = 3% of face value, so net proceeds = 97% of face. Face = 9,00,000/0.97 = ₹9,27,835. Effective cost per 90 days = 3/97 = 3.0928%; annualised simply x4 = 12.37%. Option 2 ignores the advance deduction effect on rate, option 3 ignores the grossing-up, and option 4 is an arbitrary figure.

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