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FIN 450 MODULE 5 PROBLEMS

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P15-3-Multiple changes in cash conversion cycle- Garrett Industries
turns over its inventory six times each year, it has an average
collection period of 45 days and an average payment period of 30
days. The firms annual sales are $3 million. Assume that there is
no difference in the investment per dollar of sales in inventory,
receivables, and payables, and assume a 365-day year
P15-9-Accounts receivable changes with bad debt- A firm is
evaluating an accounts change that would increase the bad debts
from 2% to 4% of sales. Sales are currently 50,000 units, the selling
price is $20 per unit, and the variable cost per unit is $15. As a
result of the proposed change, sales are forecasted to increase to
60,000 units
a) What are bad debts in dollars currently and under the proposed
change?
b) Calculate the cost of managerial bad debt to the firm.
c) Ignoring the additional profit contributions from increased sales, if
the proposed change saves $3,500 and causes no change in
average investment in accounts receivable, would you recommend
it? Explain.
d) Considering all changes in costs and benefits, would you
recommend the proposed change? Explain.
c) Compare and discuss your answers in part c and d.
P15-12-Shortening the credit period- A firm is contemplating
shorting its credit period from40 to 30 days and believers that, as a
result of this change, its average collection period will decline from
45 to 36 days. Bad-debt expenses are expected to decrease from
1.5% to 1% of sales. The firm is currently selling 12,000 units but
believers that the sales will decline to 10,000 units as a result of the
proposed changes. The sales price per unit is $56, and the variable
cost per unit is $45. The firm has a required return on equal-risk
investments of 25%. Evaluate this decision and make a
recommendation of the firm. (Note; assume a 365-day year.

P15-16 Zero-balance account Union Company is considering


establishment of a zero balance
account. The firm currently maintains an average balance of
$420,000 in its disbursement account. As compensation to the bank
for maintaining the zero balance account, the firm will have to pay a
monthly fee of $1,000 and maintain a $300,000 noninterestearning deposit in the bank. The firm currently has no other deposits
in the bank. Evaluate the proposed zero-balance account, and make
a recommendation to the firm, assuming that it has a 12%
opportunity cost.
P16-6- Cash discount decision Prairie Manufacturing has four
possible suppliers, all of which offers different credit terms. Except
for the difference in credit terms, their products and services are
virtually identical. The credit terms offered by these suppliers are
shown in the following table. (Note a 365-day year)
Supplier
Credit terms
J
1/5 net 30 EOM
K
2/20 net 80 EOM
L
1/15 net 60 EOM
M
3/10 net 90 EOM
a) Calculate the approximate cost of giving up the cash discount
from each supplier
b) If the firm needs short-term funds, which are currently available
from its commercial bank at 9%, and if each of the suppliers is
viewed separately, which, if any, of the suppliers cash discounts
should the firm give up? Explain why.
c) Now assume that the firm could stretch by 30 days its accounts
payable (net period only) from supplier M. What impacts if any
would that have on your answer in part b relative to this supplier?
P16-13-Compensating balance versus discount loan Weathers
Catering Supply, Inc. needs to borrow $150,000 for six months.
State Bank has offered to lend the funds at a 9% annual rate subject
to a 10% compensating balance. (Note; Weathers maintain $0 on
deposit in State Bank) Frost Finance Co. has offered to lend the
funds at 9% annual rate with discount-loan terms. The principal of
both loans would be payable as maturity as a single sum.
a) Calculate the effective annual rate of interest on each loan.
b) What could Weathers do that would reduce the effective annual
rate on the State Bank loan?
P16-15-Cost of commercial paper Commercial paper is usually sold
at a discount. Fan Corporation has just sold a issue of 90-day

commercial paper with a face value of $1 million. The firm has


received initial proceeds of $978,000. (Note; Assume a 365-dayyear)
a) What effective annual rate will the firm pay for financing with
commercial paper, assuming that it is rolled over every 90 days
throughout the year?
b) If a brokerage fee of $9,612 was paid from the initial process to
the investment banker for selling the issue, what effective annual
rate will the firm pay, assuming that the paper is rolled over every
90 days throughout the year?
P1620 Inventory financing Raymond Manufacturing faces a
liquidity crisisit needs a loan of $100,000 for 1 month. Having no
source of additional unsecured borrowing, the firm must find a
secured short-term lender. The firms accounts receivable are quite
low, but its inventory is considered liquid and reasonably good
collateral. The book value of the inventory is $300,000, of which
$120,000 is finishedgoods. (Note: Assume a 365-day year.)
(1) City-Wide Bank will make a $100,000 trust receipt loan against
the finished goods inventory. The annual interest rate on the loan is
12% on the outstanding loan balance plus a 0.25% administration
fee levied against the $100,000 initial loan amount. Because it will
be liquidated as inventory is sold, the average amount owed over
the month is expected to be $75,000.
(2) Sun State Bank will lend $100,000 against a floating lien on the
book value of inventory for the 1-month period at an annual interest
rate of 13%.
(3) Citizens Bank and Trust will lend $100,000 against a warehouse
receipt on the finished goods inventory and charge 15% annual
interest on the outstanding loan balance. A 0.5% warehousing fee
will be levied against the average amount
borrowed. Because the loan will be liquidated as inventory is sold,
the average loan balance is expected to be $60,000.
a. Calculate the dollar cost of each of the proposed plans for
obtaining an initial loan amount of $100,000.
b. Which plan do you recommend? Why?
c. If the firm had made a purchase of $100,000 for which it had
been given terms of 2/10 net 30, would it increase the firms
profitability to give up the discount and not borrow as recommended
in part b? Why or why not?