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Exam 22: Providing and Obtaining Credit

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Question 1

Multiple Choice

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What are the incremental pre-tax profits from this proposal?

A) $283,750
B) $250,500
C) $303,250
D) $493,750
E) $288,250

F) A) and B)
G) C) and D)

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Question 2

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Viking Farms harvests crops in roughly 90-day cycles based on a 360-day year. The firm receives payment from its harvests sometime after shipment. Due in part to the firm's rapid growth, it has been borrowing to finance its harvests using 90-day bank notes on which the firm pays 12 percent discount interest. If the firm requires $60,000 in proceeds from each note, what must be the face value of each note?

A) $61,856
B) $67,531
C) $60,000
D) $68,182
E) $67,423

F) B) and E)
G) None of the above

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A

Question 3

True/False

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The percentage aging schedule of accounts receivable is the most robust way to see if customers are, on average, paying more slowly, because it is unaffected by seasonal changes in sales.

Judy's Fashions, Inc. purchases supplies from a single supplier on terms of 1/10, net 20. Currently, Judy takes the discount, but she believes she could extend the payment to 40 days without any adverse effects if she decided not to take the discount. Judy needs an additional $50,000 to support an expansion of fixed assets. This amount could be raised by making greater use of trade credit or by arranging a bank loan. The banker has offered to loan the money at 12 percent discount interest. Additionally, the bank requires an average compensa¬ting balance of 20 percent of the loan amount. Judy already has a commercial checking account at this bank which could be counted toward the compensating balance, but the required compensating balance amount is twice the amount that Judy would otherwise keep in the account. Which of the following statements is most correct?

Bass Boats Inc. currently has sales of $1,000,000, and its days sales outstanding is 30 days. The financial manager estimates that offering longer credit terms would (1) increase the days sales outstanding to 50 days and (2) increase sales to $1,200,000. However, bad debt losses, which were 2 percent on the old sales, would amount to 5 percent on the incremental sales only (bad debts on the old sales would stay at 2 percent) . Variable costs are 80 percent of sales, and Bass has a 15 percent receivables financing cost. What would the annual incremental pre-tax profit be if Bass extended its credit period?

You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month. -Suppose you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest prepaid (a discounted loan) . Also, assume that the bank requires you to maintain a compensating balance equal to 20 percent of the initial loan value. What effective annual interest rate are you being charged?

Wentworth Greenery harvests its crops four times annually and receives payment for its crop 90 days after it is picked and shipped. However, the firm must plant, irrigate, and harvest on a near continual schedule. The firm uses 90-day bank notes to finance its operations. The firm arranges an 11 percent discount interest loan with a 20 percent compensating balance four times annually. What is the effective annual interest rate of these discount loans?

Berkeley Prints expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days dales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Also, Berkeley's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Berkeley wants to improve its profitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is, change the credit terms to 2/10, net 30. The consultants predict that sales would increase by $500,000, and that 50 percent of all customers would take the discount. The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 4 percent. -What would be the incremental bad debt losses if the change were made?

A firm's credit policy consists of which of the following items?

Assume you borrow $12,000 from the bank using a 10.19 percent "add-on", one-year installment loan, payable in four equal quarterly payments. What is the effective annual rate of interest?

Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The bank offers the choice of a 12 percent discount interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments. What is the effective rate of interest on the 10.19 percent add-on loan?

Seligstine, Inc.'s DSO was 31 days in March, and 45 days in April. Which of the following is NOT possible?

Which of the following statements is most correct?

Berkeley Prints expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days dales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Also, Berkeley's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Berkeley wants to improve its profitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is, change the credit terms to 2/10, net 30. The consultants predict that sales would increase by $500,000, and that 50 percent of all customers would take the discount. The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 4 percent. -What would be the cost to Berkeley of the discounts taken?

You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month. -What is the nominal annual add-on interest rate on this loan?

East Lansing Appliances (ELA) expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Since ELA wants to improve its profitability, the treasurer has proposed that the credit period be shortened to 15 days. This change would reduce expected sales by $500,000, but it would also shorten the DSO on the remaining sales to 30 days. Expected bad debt losses on the remaining sales would fall to 3 percent. The variable cost percentage is 60 percent, and the cost of capital is 15 percent. -What would be the incremental bad losses if the change were made?

Coverall Carpets Inc. is planning to borrow $12,000 from the bank. The bank offers the choice of a 12 percent discount interest loan or a 10.19 percent add-on, one-year installment loan, payable in 4 equal quarterly payments. What is the effective rate of interest on the 12 percent discounted loan?

Which of the following is not correct?

You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month. -How large are your monthly payments?

The collection process, although sometimes difficult, is also expensive in terms of out-of-pocket expenses.