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Exam 27: Providing and Obtaining Credit

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Question 21

Multiple Choice

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(The following information applies to the next four problems.) 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 cost of carrying receivables if the change were made?

A) -$108,750 (carrying costs would decline)
B) $116,250
C) $157,900
D) -$225,000 (carrying costs would decline)
E) $260,000

F) B) and C)
G) B) and E)

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Question 22

True/False

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

A) True
B) False

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Question 23

Multiple Choice

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Which of the following is not correct?

XYZ Company 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?

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.

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?

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?

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

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?

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.

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.

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

You need to borrow $25,000 for one year. Your 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 also expensive in terms of out-of-pocket expenses.