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Exam 22: Providing and Obtaining Credit

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Question 21

True/False

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The primary reason to monitor aggregate accounts receivable is to see if customers,on average,are paying more slowly.

A) True
B) False

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Question 22

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Which one of the following aspects of banks is considered most relevant to businesses when choosing a bank?

A) Competitive cost of services provided.
B) Size of the bank's deposits.
C) Experience of personnel.
D) Loyalty and willingness to assume lending risks.
E) Convenience of location.

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

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Question 23

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Darren's Hair Products,Inc.purchases supplies from a single supplier on terms of 1/10,net 20.Currently,Darren 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.Darren 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 compensating balance of 20 percent of the loan amount.Darren already has a commercial checking account at this bank that could be counted toward the compensating balance,but the required compensating balance amount is twice the amount that Darren would otherwise keep in the account.Which of the following statements is most correct?

The Arthos Group needs to borrow $200,000 from its bank.The bank has offered the company a 12-month installment loan (monthly payments) with 9 percent add-on interest.What is the effective annual rate (EAR) of this loan?

Credit standards refer to the financial strength and importance of a potential customer to the firm required in order to qualify for credit.

Exhibit 27.3 Van Doren housing 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. Also, Van Doren's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Van Doren wants to improve its porfitability, 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. -Refer to Exhibit 27.3.What would be the incremental cost of carrying receivables if the change were made?

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

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.

The credit period is the amount of time it takes to do a credit search on a potential customer.

Campbell Computing 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 Campbell has a 15 percent receivables financing cost.What would the annual incremental pre-tax profit be if Bass extended its credit period?

Which of the following is not correct?

Exhibit 22.1 Your brother has just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires him to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. He currently has $20,000 in his checking account, and he plans to maintain this balance. The loan is an add-on installment loan which he will repay in 12 equal monthly installments, beginning at the end of the first month. -Refer to Exhibit 22.1.How large are your brother's monthly payments?

If sales are seasonal,the days sales outstanding will fluctuate from month to month,even if the amount of time customers take to pay remains unchanged.

No Tree Too Tall,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?

Harris Flooring Inc.is planning to borrow $12,000 from the bank for new sanding machines.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?

Exhibit 27.2 Firm A expects to have sales 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. 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 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. -Refer to Exhibit 27.2.What are the incremental pre-tax profits from this proposal?

Exhibit 27.3 Van Doren housing 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. Also, Van Doren's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Van Doren wants to improve its porfitability, 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. -Refer to Exhibit 27.3.What would be the incremental bad debt losses if the change were made?

DSO analysis 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.