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Exam 27: Providing and Obtaining Credit

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Question 1

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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?

A) $111,000
B) $100,000
C) $112,360
D) $89,000
E) $108,840

F) A) and D)
G) D) and E)

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Question 2

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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?

A) 5.10%
B) 10.19%
C) 12.00%
D) 20.38%
E) 30.57%

F) D) and E)
G) A) and C)

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Question 3

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

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.How large are your brother's monthly payments?

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.

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?

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?

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

The Arthos Group 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?

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

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?

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 would be the cost to Van Doren of the discounts taken?

Which of the following statements is most correct?

No Tree Too Tall,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 10.19 percent add-on loan?

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

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 are the incremental pre-tax profits from this proposal?

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

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?