Exam 22: Providing and Obtaining Credit

The uncollected balances schedule is constructed at the end of a quarter by dividing the dollar amount of remaining receivables from each month in that quarter by that month's sales.

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?

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?

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?

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.

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?

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

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 cost of carrying receivables if the change were made?

Which of the following is not correct for a firm with seasonal sales and customers who all pay promptly at the end of 30 days?

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 cost of carrying receivables if this change were made?

The Somerset Bank offered Blakemore Inc. the following loan alternatives in response to its request for a $75,000, 1-year loan. Alternative 1: 7 percent discount interest, with a 10 percent compensating balance. Alternative 2: 8 percent simple interest, with interest paid monthly. What is the effective annual rate on the cheaper loan?

Which of the following is not correct?

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?

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?

Tillyard Inc. requires a $25,000 1-year loan. The bank offers to make the loan, and it offers you three choices: (1) 15 percent simple interest, annual compounding; (2) 13 percent nominal interest, daily compounding (360-day year); (3) 9 percent add-on interest, 12 end-of-month payments. The first two loans would require a single payment at the end of the year, the third would require 12 equal monthly payments beginning at the end of the first month. What is the difference between the highest and lowest effective annual rates?

The collection process, although sometimes difficult, is a fairly inexpensive component of doing business.

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?

Cash discounts are mostly used to get new customers in the door since existing customers almost always use the delayed payment terms.