Answered: Harrelson Inc. currently has $750,000…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 3P

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Similar questions

The Raattama Corporation had sales of $3.5 million last year, and it earned a 5% return (after taxes) on sales. Recently, the company has fallen behind in its accounts payable. Although its terms of purchase are net 30 days, its accounts payable represents 60 days’ purchases. The company’s treasurer is seeking to increase bank borrowing in order to become current in meeting its trade obligations (that is, to have 30 days’ payables outstanding). The company’s balance sheet is as follows (in thousands of dollars): How much bank financing is needed to eliminate the past-due accounts payable? Assume that the bank will lend the firm the amount calculated in part a. The terms of the loan offered are 8%, simple interest, and the bank uses a 360-day year for the interest calculation. What is the interest charge for 1 month? (Assume there are 30 days in a month.) Now ignore part b and assume that the bank will lend the firm the amount calculated in part a. The terms of the loan are 7.5%, add-on interest, to be repaid in 12 monthly installments. What is the total loan amount? What are the monthly installments? What is the APR of the loan? What is the effective rate of the loan? Would you, as a bank loan officer, make this loan? Why or why not?
Now assume that it is several years later. The brothers are concerned about the firm’s current credit terms of net 30, which means that contractors buying building products from the firm are not offered a discount and are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80% (by dollar volume) of the firm’s paying customers generally pay the full amount on Day 30; the other 20% pay, on average, on Day 40. Of the firm’s gross sales, 2% ends up as bad-debt losses. The brothers are now considering a change in the firm’s credit policy. The change would entail: (1) changing the credit terms to 2/10, net 20, (2) employing stricter credit standards before granting credit, and (3) enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2% discount, but all others would have to pay the full amount after only 20 days. The brothers believe the discount would both attract additional customers and encourage some existing customers to purchase more from the firm—after all, the discount amounts to a price reduction. Of course, these customers would take the discount and hence would pay in only 10 days. The net expected result is for sales to increase to $1,100,000; for 60% of the paying customers to take the discount and pay on the 10th day; for 30% to pay the full amount on Day 20; for 10% to pay late on Day 30; and for bad-debt losses to fall from 2% to 1% of gross sales. The firm’s operating cost ratio will remain unchanged at 75%, and its cost of carrying receivables will remain unchanged at 12%. To begin the analysis, describe the four variables that make up a firm’s credit policy and explain how each of them affects sales and collections.

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