Directions: Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 20 points for this homework assignment.
1. 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. DSO will vary from month to month.
b. The quarterly uncollected balances schedule will be the same in each quarter.
c. The level of accounts receivable will be constant from month to month.
d. The ratio of accounts receivable to sales will vary from month to month.
e. The level of accounts receivable at the end of each quarter will be the same.
2. Which of the following statements is most correct?
a. If credit sales as a percentage of a firm's total sales increases, and the volume of credit sales also increases, then the firm's accounts receivable will automatically increase.
b. It is possible for a firm to overstate profits by offering very lenient credit terms which encourage additional sales to financially "weak" firms. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts.
c. A firm with excess production capacity and relatively low variable costs would not be inclined to extend more liberal credit terms to its customers than a firm with similar costs that is operating close to capacity.
d. Firms use seasonal dating primarily to decrease their DSO.
e. Seasonal dating with terms 2/15, net 30 days, with April 1 dating, means that if the original sale took place on February 1st, the customer can take the discount up until March 15th, but must pay the net invoice amount by April 1st.
3. 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?
a. 5.10%
b. 10.19%
c. 12.00%
d. 20.38%
e. 30.57%
4. 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 baddebt 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 bad losses if the change were made?
a. $315,000
b. $260,500
c. -$260,500 (bad debt losses would decline)
d. -$315,000 (Bad debt losses would decline)
e. $0 (no change would occur)
5. Judy's Fashions, Inc. purchases supplies from a single supplier on terms of 1/10, net 20. Currently, Judy 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. Judy 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. Judy already has a commercial checking account at this bank which could be counted toward the compensating balance, but the required compensating balance amount is twice the amount that Judy would otherwise keep in the account. Which of the following statements is most correct?
a. The cost of using additional trade credit is approximately 36 percent.
b. Considering only the explicit costs, Judy should finance the expansion with the bank loan.
c. The cost of expanding trade credit using the approximation formula is less than the cost of the bank loan. However, the true cost of the trade credit when compounding is considered is greater than the cost of the bank loan.
d. The effective cost of the bank loan is decreased from 17.65 percent to 15.38 percent because Judy would hold a cash balance of one-half the compensating balance amount even if the loan were not taken.
e. If Judy had transaction balances that exceeded the compensating balance requirement, the effective cost of the bank loan would be 12.00 percent.