Question 1

Taylor Textbooks Inc.buys on terms of 2/15, net 50 days.It does not take discounts, and it typically pays on time, 50 days after the invoice date.Net purchases amount to $450, 000 per year.On average, what is the dollar amount of costly trade credit (total credit - free credit)the firm receives during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

11ea1b84_8bd0_79b8_a54a_130ac75284c5_TB3581_00 
Purchases/day = $450, 000/365 = $1, 233
Avg.trade credit = Average A/P = Days to payment ×Net purchases/day = $61, 644
Free trade credit = Discount days ×Purchases/day = $18, 493
Costly trade credit = Total credit - Free credit = $43, 151
Alternatively, Costly TC = (Days to pmtrue.- Disc.days)×(Purchases/day)= $43, 151

Question 2

Fontana Painting had the following data for the most recent year (in millions).The new CFO believes that the company could improve its working capital management sufficiently to bring its NWC and CCC up to the benchmark companies' level without affecting either sales or the costs of goods sold.Fontana finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year.If these changes had been made, by how much would the firm's pre-tax income have increased?

Accepted Answer

11ea1b84_8bd0_eeef_a54a_1f13f8d86577_TB3581_00 
Reduction in NWC = Old - New = $23, 767
Interest rate = 8%
Savings = Interest rate ×Reduction in NWC = $1, 901

Question 3

Refer to Exhibit 21.1.Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same.In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

Accepted Answer

11ea1b84_8bd1_d95f_a54a_8f320e941e5d_TB3581_00 
Restricted:
 11ea1b84_8bd1_d960_a54a_eda12bf74ca2_TB3581_00 
 11ea1b84_8bd1_d961_a54a_33fd5d739ea4_TB3581_00 
ROE = Net income/Equity = 7.24%
Relaxed ROE from above: 5.00%
Difference in ROE = 2.24%

Question 4

Famous Farm's payables deferral period (PDP)is 50 days (on a 365-day basis), accounts payable are $100 million, and its balance sheet shows inventory of $125 million.What is the inventory turnover ratio?

Accepted Answer

11ea1b84_8bd1_6425_a54a_45055937cfd9_TB3581_00 
Use PDP equation to find sales:
PDP = Receivables/(COGS/365)
COGS = 365(Payables)/DSO = $730
Inventory turnover = COGS/Inventory = 5.84

Question 5

Safety Window and Door Co.buys on terms of 2/15, net 60 days.It does not take discounts, and it typically pays on time, 60 days after the invoice date.Net purchases amount to $450, 000 per year.On average, how much "free" trade credit does the firm receive during the year? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

11ea1b84_8bd0_52a7_a54a_bd8b1a8cf07a_TB3581_00 
Purchases/day = $450, 000/365 = $1, 233
Free credit = Disc.days ×Purchases/day = $18, 493

Question 6

Howes Inc.purchases $4, 562, 500 in goods per year from its sole supplier on terms of 2/15, net 50.If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)

Accepted Answer

11ea1b84_8bd0_2b95_a54a_a1e630b81b3c_TB3581_00 EAR = [1 + Disc.%/(100 - Disc.%)][³??/??????? ???? ? ????.???????] -1 = 23.45%

Question 7

Noddings Inc.needs to raise more capital because its business is booming.The company purchases supplies on terms of 1/10 net 20, and it currently takes the discount.One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects.What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)

Accepted Answer

11ea1b84_8bd0_a0cb_a54a_9f11389b1a04_TB3581_00 EAR = [1 + Disc.%/(100 - Disc.%)][³??/??????? ???? ? ????.???????] - 1 = 13.01%

Question 8

Sanders Enterprises arranged a revolving credit agreement of $9, 000, 000 with a group of banks.The firm paid an annual commitment fee of 0.5% of the unused balance of the loan commitment.On the used portion of the revolver, it paid 1.5% above prime for the funds actually borrowed on a simple interest basis.The prime rate was 3.25% during the year.If the firm borrowed $6, 000, 000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar annual cost of the revolver?

Accepted Answer

11ea1b84_8bd0_c7dc_a54a_0ff1e3fac929_TB3581_00 11ea1b84_8bd0_c7dd_a54a_e10647f4d059_TB3581_00

Question 9

Arnold Inc.purchases merchandise on terms of 2/10 net 30, and it always pays on the 30th day.The CFO calculates that the average amount of costly trade credit carried is $375, 000.What is the firm's average accounts payable balance? (Assume a 365-day year.)

Accepted Answer

11ea1b84_8bd1_1602_a54a_9f7325adfa76_TB3581_00 11ea1b84_8bd1_3d13_a54a_2baa39e9cef4_TB3581_00

Question 10

Andrews Corporation buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days.What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)

Accepted Answer

11ea1b84_8bd0_52a6_a54a_c54cbf30328d_TB3581_00 EAR = [1 + Disc.%/(100 - Disc.%)][³??/??????? ???? ? ????.???????] - 1 = 15.89%

Question 11

Refer to Exhibit 21.1.If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

Accepted Answer

11ea1b84_8bd1_b249_a54a_f9f6070c120d_TB3581_00 
 11ea1b84_8bd1_b24a_a54a_11c159a4e5bb_TB3581_00 
Restricted:
 11ea1b84_8bd1_b24b_a54a_dbdf5287a5a0_TB3581_00 
Relaxed:
 11ea1b84_8bd1_b24c_a54a_51f193705952_TB3581_00 
 11ea1b84_8bd1_b24d_a54a_57963c53feda_TB3581_00 Difference in interest = $9, 818

Question 12

Refer to Exhibit 21.1.What's the difference in the projected ROEs under the restricted and relaxed policies?

Accepted Answer

11ea1b84_8bd1_d95e_a54a_47152311e3a1_TB3581_00 Difference in ROEs = 1.50%

Question 13

Fairweather Corporation purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off the discount)are $800, 000 per year.What is the maximum dollar amount of costly trade credit the firm could get, assuming it abides by the supplier's credit terms? (Assume a 365-day year.)

Accepted Answer

11ea1b84_8bd0_79b9_a54a_ed07b62d2833_TB3581_00 
Net purchases = Gross(1 - Disc.%)= $784, 000
Net per day = Net/365 = $2, 148
Total trade credit = Net days ×Net per day = $85, 918
Free credit = Net per day ×Discount days = $32, 219
Costly credit = Total credit - Free credit = $53, 699

Question 14

Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days.Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day 30.You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%.But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost)of its costly trade credit, using a 365-day year?

Accepted Answer

11ea1b84_8bd1_1601_a54a_0b02790f6364_TB3581_00 EAR = [1 + Disc.%/(100 - Disc.%)][³??/??????? ???? ? ????.???????] - 1 = 63.49%

Question 15

Hinkle Corporation buys on terms of 2/15, net 60 days.It does not take discounts, and it typically pays on time, 60 days after the invoice date.Net purchases amount to $550, 000 per year.On average, what is the dollar amount of total trade credit (costly + free)the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)

Accepted Answer

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Purchases/day = $550, 000/365 = $1, 507
Average trade credit = Average A/P = Days to payment ×Net purchases/day = $90, 411

Question 16

Blueroot Inc.is considering a change in its financing policy.Currently, it uses maximum trade credit by not taking discounts on its purchases.The standard industry credit terms offered by all its suppliers are 2/10 net 30 days, and the firm pays on time.The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts.The firm wants to determine the effect of this policy change on its net income.Its net purchases are $11, 760 per day, using a 365-day year.The interest rate on the notes payable is 10%, and the tax rate is 40%.If the firm implements the plan, what is the expected change in net income?

Accepted Answer

11ea1b84_8bd1_3d14_a54a_e5be01ad40fe_TB3581_00 
A/PN? d?sc.= Net purchases/day ×Actual days to payment
A/PN? d?sc.= $11, 760 ×30 = $352, 800
A/PD?sc.= Net purchases/day ×Discount days
A/PD?sc.= $11, 760 ×10 = $117, 600
Amount needed to be financed = A/PN? d?sc.- A/PD?sc.Amount needed to be financed = $352, 800 - $117, 600 = $235, 200
Additional interest cost = Amount needed to be financed ×Annual interest rate
Additional interest cost = $235, 200 ×10.00% = $23, 520
Gross purchases = (Net purchases/day ×365)/(1 - Disc.%)
Gross purchases = $11, 760 ×365/98.00% = $4, 380, 000
Discounts lost = Gross purchases ×Discount %
Discounts lost = $4, 380, 000 ×2.00% = $87, 600
Pre-tax savings = Discounts lost - Additional interest
Pre-tax savings = $87, 600 - $23, 520 = $64, 080
After-tax savings = Pre-tax savings ×(1 - T)
After-tax savings = $64, 080 ×60.00% = $38, 448

Question 17

During the coming year, Gold & Gold wants to increase its free cash flow by $180 million, which should result in a higher EVA and stock price.The CFO has made these projections for the upcoming year:

What increase in net working capital (in millions of dollars)would enable the firm to meet its target increase in FCF?

Accepted Answer

11ea1b84_8bd1_8b37_a54a_adecbf319ae4_TB3581_00 11ea1b84_8bd1_8b38_a54a_67fde773eac2_TB3581_00

Question 18

Monar Inc.'s CFO would like to decrease its cash conversion cycle by 10 days (based on a 365 day year).The company carries average inventory of $750, 000.Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period.The firm buys on terms of net 30 days, and it pays on time.The CFO believes he can reduce the average inventory to $647, 260 with no effect on sales.By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?

Accepted Answer

11ea1b84_8bd0_eef0_a54a_99cc3d88fc0c_TB3581_00 Reduction in A/R = Orig.A/R - New A/R = $136, 986

Quiz 16: Supply chains and working capital management

Famous Farm's payables deferral period (PDP) is 50 days (on a 365-day basis) , accounts payable are $100 million, and its balance sheet shows inventory of $125 million.What is the inventory turnover ratio?

Howes Inc.purchases $4, 562, 500 in goods per year from its sole supplier on terms of 2/15, net 50.If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)

Arnold Inc.purchases merchandise on terms of 2/10 net 30, and it always pays on the 30th day.The CFO calculates that the average amount of costly trade credit carried is $375, 000.What is the firm's average accounts payable balance? (Assume a 365-day year.)

Andrews Corporation buys on terms of 2/8, net 45 days, it does not take discounts, and it actually pays after 58 days.What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)

Refer to Exhibit 21.1.If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

Refer to Exhibit 21.1.What's the difference in the projected ROEs under the restricted and relaxed policies?