Exam 27: Providing and Obtaining Credit

Exhibit Van Doren 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 dales 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 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. -Refer to Exhibit Van Doren.What are the incremental pre-tax profits from this proposal?

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?

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.

Exhibit Reese Brothers Reese Brothers Publishers Inc (RBP) 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 RBP 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. -Refer to Exhibit Reese Brothers.What would be the incremental bad losses if the change were made?

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

Gladys Turner borrowed $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?

Exhibit Reese Brothers Reese Brothers Publishers Inc (RBP) 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 RBP 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. -Refer to Exhibit Reese Brothers.What are the incremental pre-tax profits from this proposal?

Faircross Farms harvests its crops four times annually and receives payment for its crop 90 days after it is picked and shipped.However, planting, irrigating, and harvesting must be done on a nearly 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?

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?

Danby Design Inc.has approached the bank with its plan to borrow $12,000.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 approximate (nominal) rate of interest on the 10.19 percent add-on loan?

Which of the following is not correct?

Exhibit Brother's Loan 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 Brother's Loan.How large are your brother's monthly payments?

Maxwell Gardens requires a $100,000 annual loan in order to pay laborers to tend and harvest its organic vegetable crop.Maxwell borrows on a discount interest basis at a nominal annual rate of 11 percent.If Maxwell must actually receive $100,000 net proceeds to finance its crop, then what must be the face value of the note?

Which of the following statements is most correct?

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

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.

Exhibit Van Doren 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 dales 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 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. -Refer to Exhibit Van Doren.What would be the incremental bad debt losses if the change were made?

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