A. 1,500,000 daily collections x 2 days = 3,000,000 additional collections
Invested at 9% = 3,000,000 x 9% = $270,000 per year
If the cost is $200,000, then this is a good investment
B.a) Incremental net income
Additional sales
Less: Uncollectible accounts (15% of new sales)
Annual additional revenue
Less: Production and selling costs (80%)
Less: collection costs (2%)
Additional before-tax income
Less: Taxes (30%)
Additional new income
2,000,000
300,000
1,700,000
1,600,000
40,000
60,000
18,000
42,000
b. Average investment in receivables
Credit sales turnover = 2,000,000 additional sales/4 times a year of receivables turnover = $500,000
Incremental return on investment
Additional net income/average investment = $42,000/$500,000 = 8.4%
c. No, don’t enter the market because the return on investment is not as high as the minimum return on investment
required by the company.
d. 5 C’s of credit: Character, capital, capacity, conditions, collateral
C.a.
April = 33,088,000/41,467,000 = 80%
May = 4%*
June = 3%
July = 14%
*These numbers are rounded to the nearest percent.
b. Average collection period = A/R divided by average daily credit sales
= 41,467,000
= 41,467,000
= 26.3 days
189,000,000/120
1,575,000
c. Yes
d. Potentially more satisfied because a clear majority is collected. The only concern is that 14% are most likely
uncollectible.
e. Provides more detail about the accounts and how they are collected
D. a. Failing to take the discount = Discount % x
100% - Discount %
360
Final due date – Discount period
= 2%
100% - 2%
x
360
30-10
=2% x 18 = 36%
b. Effective interest rate =
Interest
Principal
First City =
360
20
400
x
40,000
x
360
Days Outstanding
= .01 x 18 = 18%
Upstart =
320
x
360
=
.00806 x 18 = 14.5%
40,000 – 320* 20
*subtract the interest that is paid upfront for the discounting
c. Use Upstart because it’s the lowest rate and borrow the money to take the discount.
E.a. Total inventory Cost = Total Ordering + Total Carrying Cost
Ordering = 75 x 4 = 300
Carrying = [Average inventory (50,000/2) + 200 safety stock] x $15 carrying cost
= 25,200 x 15
= $378,000
Total Inventory Cost = $300 + 378,000 = $378,300
b. EOQ = 2SO = 2x200,000x75
√ C
√
15
= 1,414.20 = 1,414
c. Ave Inventory ( EOQ/2 = 1414/2 = 707 ) + Safety Stock of 200 = 907
d. Ordering Costs = 200,000 sales / 1414 EOQ ordering amount = 141 orders per year
= 141 orders x $75 per order = $10,575
Carrying Costs = 907 ave inventory x $15 carrying cost = $13,605
Total Inventory Cost = 10,575 + 13,605 = $24,180*
(*Note the difference from what the company currently pays in part a. That is the beauty of the EOQ idea of finding the
most efficient amount of inventory to order at a time to minimize cost. Can you see why companies work hard to control
inventory?)
F. a. Effective Rate =
Interest
Principal – Compensating Balance
x
360
Days Outstanding
Interest = 1,000,000 x 10% = 100,000
(100,000/1,000,000 – 100,00) x 360/360 = 11.11%
b. Effective Interest Rate = Interest x
360
Principal – Interest
Days Outstanding
= (100,000/1,000,000 – 100,000) x 360/360
= 11.11%
c. Installment loan formula
Effective Rate = 2x12x100,000
13 x 1,000,000
=
18.5%
d. Subtract both interest and compensating balance from principal
=
100,000
x
360
1,000,000 – 100,000 – 50,000
360
= 100,000/850,000
= 11.8%
e. Amount to be borrowed = Amount Needed/ (1-c) = 1,000,000 / (1-10%) = $1,111,111
G. This could include using accounts receivable as collateral for a loan, selling accounts receivables (i.e. factoring),
using inventory or work in progress as collateral, general borrowing, or using trade credit from suppliers.
H. This could be anything.
I. a. Remember that risk is higher with short-term loans because you are uncertain of what the rates will be in the
future and you may not be able to get the money needed for a loan. With long-term loans, you lock in the money at
a rate and the risk is therefore lower. That is why long-term loans are generally less expensive than short term loans.
b. Generally, current assets are financed with current debt options listed in letter G.
c. Generally, long term assets are financed with long term debt or equity. *
* Check chapter 6 for problems illustrating this.