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Exam 27: Providing and Obtaining Credit

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Question 21

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

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Question 22

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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?

A) The quarterly uncollected balances schedule will be the same in each quarter.
B) The level of accounts receivable will be constant from month to month.
C) The ratio of accounts receivable to sales will vary from month to month.
D) The level of accounts receivable at the end of each quarter will be the same.
E) DSO will vary from month to month.

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Question 23

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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?

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

Sunnydale Organics,Inc.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?

Exhibit 27.1 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 27.1.What is the nominal annual add-on interest rate on this loan?

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

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

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?

When deciding whether to offer a discount for cash payment,a firm must balance the profits from additional sales with the lost revenues from the discount.

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 27.2 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 27.2.What would be the incremental cost of carrying receivables if this change were made?

Exhibit 27.2 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 27.2.What would be the incremental bad losses if the change were made?

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.

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.

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?

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

Which of the following is not correct?