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9609 · 5.2.2

Internal and external sources of finance — practice questions

Practice and worked examples for 9609 Internal and external sources of finance. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

A business has the following financial needs. Match each need to the most suitable source of finance and perform any necessary calculations. (a) Replace a delivery van costing $40,000 with a 5-year life. (b) Cover a weekly wage bill of $15,000 for 2 weeks because a major customer is paying late. (c) Fund a $500,000 R&D project for a new, unprofitable tech start-up.

Show solution outline

(a) Bank loan or leasing. A 5-year bank loan matches the asset's life. Leasing would involve monthly payments instead of a large upfront cost. For example, a 5-year lease at $850/month would cost $850 x 60 months = $51,000 in total.

(b) Overdraft. This is a short-term working capital need. The amount required is 2 weeks x $15,000/week = $30,000. An overdraft is a flexible facility designed for such temporary cash shortfalls.

(c) Venture capital or crowdfunding. The business is unprofitable, so it cannot use retained profit and is unlikely to secure a large bank loan. It needs equity finance from investors who are willing to take a high risk for a potential high return on their $500,000 investment.

Worked example 2

A logistics company, 'Swift Deliveries Ltd', needs to acquire a new delivery truck costing $80,000. The truck has an expected useful life of 4 years. The company is evaluating two financing options:

  • Option 1: Bank Loan: A 4-year bank loan for the full amount at an interest rate of 7% per annum. The total amount to be repaid over the 4 years is calculated to be 91,775.91,775.
  • Option 2: Hire Purchase: An agreement with a 4-year term. It requires an initial deposit of $8,000 and 48 monthly payments of $1,850.

Calculate the total cost of each option and recommend which one Swift Deliveries Ltd should choose, justifying your answer.

Show solution outline

Step 1: Calculate the total cost of the Bank Loan.

The question states the total repayment amount for the loan.

  • Total Cost of Loan = Total Repayments = **91,775∗∗91,775**
  • (The total interest paid would be 91,775−91,775 - 80,000 = 11,775)11,775)

Step 2: Calculate the total cost of the Hire Purchase agreement.

Hire Purchase cost consists of the deposit plus all monthly payments.

  • Initial Deposit = 8,0008,000
  • Total Monthly Payments = 48 months × $1,850/month = $88,800
  • Total Cost of Hire Purchase = Deposit + Total Monthly Payments
  • Total Cost of Hire Purchase = 8,000+8,000 + 88,800 = **96,800∗∗96,800**

Step 3: Compare costs and provide a justified recommendation.

  • Cost Comparison:

    • Bank Loan Total Cost: 91,77591,775
    • Hire Purchase Total Cost: 96,80096,800
    • The bank loan is cheaper by 96,800−96,800 - 91,775 = 5,025.5,025.

  • Recommendation: Based on the total cost, the bank loan is the more financially attractive option.

  • Justification: The bank loan has a lower total cost, saving the company over $5,000. With both a loan and hire purchase, the business will own the asset at the end of the term. However, the hire purchase requires an $8,000 upfront deposit, which impacts immediate cash flow, whereas the loan provides the full $80,000. The loan will increase the company's gearing, which is a key consideration. The hire purchase might be easier to secure than a bank loan if the company has a poor credit history.

    Conclusion: Swift Deliveries Ltd should choose the bank loan, provided it can be secured and the impact on its gearing ratio is acceptable, as it is the lowest-cost method for acquiring the asset.

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