Exam 22: Providing and Obtaining Credit

Picard Orchards requires a $100,000 annual loan in order to pay laborers to tend and harvest its fruit crop. Picard borrows on a discount interest basis at a nominal annual rate of 11 percent. If Picard must actually receive $100,000 net proceeds to finance its crop, then what must be the face value of the note?

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

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

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.

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?

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

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.

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

First National Bank of Micanopy has offered you the following loan alternatives in response to your 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?

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.

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?

East Lansing Appliances (ELA) 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 ELA 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. -What are the incremental pre-tax profits from this proposal?

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?

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 approximate (nominal) rate of interest on the 10.19 percent add-on loan?

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?

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

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

East Lansing Appliances (ELA) 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 ELA 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. -What would be the incremental cost of carrying receivables if this change were made?