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Exam 22: Providing and Obtaining Credit

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Question 1

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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?

A) 9.50%
B) 10.19%
C) 15.99%
D) 16.98%
E) 20.38%

F) A) and E)
G) All of the above

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Question 2

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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.

A) True
B) False

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Question 3

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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?

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?

Suppose that you're planning a vacation and 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?

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?

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?

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

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 would be the incremental bad losses if the change were made?

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?

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?

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

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

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 are the incremental pre-tax profits from this proposal?

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.

Which of the following statements is most correct?

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

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

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

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 cost to Van Doren of the discounts taken?