Expert answer:2 Assignments. 2 no later than Wednesday afternoon
Expert answer:ASSIGNMENT 1:Consider the following companies:WalmartGeneral MotorsA local doughnut shop with 2 employeesWhich of those companies is most likely to use the EOQ model for ordering inventor? And which is the least likely? Support your answer fully!——-ASSIGNMENT 2:Aqua Pure purchases 50,000 gallons of distilled water each year. Ordering costs are $100 per order, and the carrying cost, as a percentage of inventory value, is 80 percent. The purchase price to CCC is $0.50 per gallon. Management currently orders the EOQ each time an order is placed. No safety stock is carried. The supplier is now offering a quantity discount of $0.03 per gallon if CCC orders 10,000 gallons at a time. Should CCC take the discount? WHY?Show your work for full credit!
ifm12_ch22_show.pptx
ifm12_ch23_show.pptx
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Brigham & Daves
Intermediate Financial
Management, 12e
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
Chapter 22
Providing and Obtaining Credit
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
Topics in Chapter
Receivables management
Credit policy
Days sales outstanding (DSO)
Aging schedules
Payments pattern approach
Cost of bank loans
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Elements of Credit Policy
Cash Discounts: Lowers price. Attracts
new customers and reduces DSO.
Credit Period: How long to pay?
Shorter period reduces DSO and
average AR, but it may discourage
sales.
(More…)
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4
Credit Policy (Continued)
Credit Standards: Tighter standards
reduce bad debt losses, but may reduce
sales. Fewer bad debts reduces DSO.
Collection Policy: Tougher policy will
reduce DSO, but may damage customer
relationships.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5
Receivables Monitoring
Assume the following sales estimates:
January
February
March
$100
200
300
April
May
June
$300
200
100
Terms of sale: Net 30.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
Expected Collections
30% pay on Day 10 (month of sale).
50% pay on Day 40 (month after sale).
20% pay on Day 70 (2 months after
sale).
Annual sales = 18,000 units @
$100/unit.
365-day year.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
7
What is the firm’s expected DSO
and average daily sales (ADS)?
DSO= 0.30(10) + 0.50(40) +
0.20(70)= 37days.
How does this compare with the firm’s
credit period?
ADS=
18,000($100)
365
=$4,931.51 per day.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
8
What is the expected average accounts receivable (AR)
level? How much of this amount must be financed if
the profit margin is 25%?
AR = (DSO)(ADS) = 37($4,931.51)
= $182,466
0 .75($182,466) = $136,849.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
If notes payable are used to finance the
AR investment, what does the firm’s
balance sheet look like?
Assets
AR
Liabilities & Equity
$182,466
Notes payable
Retained
earnings
$136,849
45,617
$182,466
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
If bank loans cost 12 percent, what is the
annual dollar cost of carrying the
receivables?
Cost of carrying receivables
= 0.12($136,849)
= $16,422.
In addition, there is an opportunity cost
of not having the use of the profit
component of the receivables.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
What are some factors which
influence a firm’s receivables level?
Receivables are a function of average
daily sales and days sales outstanding.
State of the economy, competition
within the industry, and the firm’s credit
policy all influence a firm’s receivables
level.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
What are some factors which influence
the dollar cost of carrying receivables?
The lower the profit margin, the higher
the cost of carrying receivables,
because a greater portion of each sales
dollar must be financed.
The higher the cost of financing, the
higher the dollar cost.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
New Data on Collections
30% of the firm’s customers pay in the
month of sale
50% pay in the month following the
sale
Remaining 20% pay in the second
month following the sale
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
What would the receivables level
be at the end of each month?
AR = 0.7(Sales in that month) + 0.2(Sales in
previous month).
Month
Sales
AR
January
$100
$ 70
February
200
160
March
300
250
April
300
270
May
200
200
June
100
110
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15
What is the firm’s forecasted average daily sales
(ADS) for the first 3 months? For the entire
half-year? (assuming 91-day quarters)
Avg. Daily Sales = Total Sales
# of days
1st Qtr: $600/91= $6.59
2nd Qtr: $600/91= $6.59
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16
What DSO is expected at the end
of March? At the end of June?
AR
DSO =
.
ADS
1st Qtr: $250/$6.59 = 37.9 days.
2nd Qtr: $110/$6.59 = 16.7 days.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17
What does the DSO indicate
about customers’ payments?
It appears that customers are paying
significantly faster in the second quarter
than in the first.
However, the receivables balances were
created assuming a constant payment
pattern, so the DSO is giving a false
measure of payment performance.
Underlying cause is seasonal variation.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
Construct an aging schedule for the
end of March and the end of June.
Age of
account
(Days)
0-30
31-60
61-90
March
June
AR
%
AR
$210
84%
$70
40
16
40
0
0
0
$250
100%
$110
Do aging schedules “tell the truth?”
%
64%
36
0
100%
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
19
Uncollected Balances Schedules
for the End of March
Months
Sales
Contrib.
to AR
January
$100
$0
0%
February
200
40
20
March
300
210
70
$250
90%
End of Qtr. AR
AR to
Sales
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
20
Uncollected Balances
Schedules for the End of June
Months
Sales
Contrib.
to AR
April
$300
$0
0%
May
200
40
20
June
100
70
70
$110
90%
End of Qtr. AR
AR to
Sales
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
21
Do the uncollected balances schedules
properly measure customers’ payment
patterns?
The focal point of the uncollected
balances schedule is the receivables to-sales ratio.
There is no difference in this ratio
between March and June, which tells us
that there has been no change in
payment pattern.
(More…)
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
22
Do the uncollected balances schedules
properly measure customers’ payment
patterns?
The uncollected balances schedule gives a true
picture of customers’ payment patterns, even
when sales fluctuate.
Any increase in the AR to sales ratio from a
month in one quarter to the corresponding
month in the next quarter indicates a
slowdown in payment.
The “bottom line” gives a summary of the
changes in payment patterns.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
23
Projecting Accounts
Receivable
Assume it is now July and you are
developing pro forma financial
statements for the following year.
Furthermore, sales and collections in
the first half-year matched predicted
levels. Using Year 2 sales forecasts,
what are next year’s pro forma
receivables levels for the end of March
and June?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
24
March 31
Months
January
Predicted AR Predicted
Predicted
to Sales
Contribution
Sales
Ratio
to AR
$150
0%
$
0
February
300
20
60
March
500
70
350
Projected March 31 AR balance
$410
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25
June 30
Months
Predicted AR Predicted
Predicted
to Sales
Contribution
Sales
Ratio
to AR
April
$400
0%
May
300
20
60
June
200
70
140
Projected June 30 AR balance
$
0
$200
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
26
What four variables make up
a firm’s credit policy?
Cash discounts
Credit period
Credit standards
Collection policy
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
27
Disregard any previous
assumptions
Current credit policy:
Credit terms = Net 30.
Gross sales = $1,000,000.
80% (of paying customers) pay on Day 30.
20% pay on Day 40.
Bad debt losses = 2% of gross sales.
Operating cost ratio = 75%.
Cost of carrying receivables = 12%.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
28
The firm is considering a change
in credit policy
New credit policy:
Credit terms = 2/10, net 20.
Gross sales = $1,100,000.
60% (of paying customers) pay on Day 10.
30% pay on Day 20.
10% pay on Day 30.
Bad debt losses = 1% of gross sales.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
29
What is the DSO under the current
and the new credit policies?
Current:
DSO0 = 0.8(30) + 0.2(40)
= 32 days.
New:
DSON = 0.6(10) + 0.3(20) + 0.1(30)
= 15 days.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
30
What are bad debt losses under the
current and the new credit policies?
Current:
BDL0 =
=
New:
BDLN =
=
0.02($1,000,000)
$20,000.
0.01($1,100,000)
$11,000.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
31
What are the expected dollar costs of
discounts under the current and the new
policies?
Discounto = $0.
DiscountN =
0.6(0.02)(0.99)($1,100,000)
= $13,068.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
32
What are the dollar costs of carrying
receivables under the current and the
new policies?
Costs of carrying receivablesO
=($1,000,000/365)(32)(0.75)(0.12)
=$7,890.
Costs of carrying receivablesN
=($1,100,000/365)(15)(0.75)(0.12)
=$4,068.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
33
What is the incremental after-tax
profit associated with the change in
credit terms?
New
Gross Sales
Less: Disc.
Net Sales
Production
costs
Profit before
credit costs
and taxes
Old
Difference
$1,100,000
$1,000,000
$100,000
13,068
0
13,068
$1,086,932
$1,000,000
$ 86,932
825,000
750,000
75,000
$ 261,932
$ 250,000
$ 11,932
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
34
Should the company make the
change?
New
Old
Diff.
Prof. bef. credit costs
and taxes
Credit-related costs
$261,932 $250,000 $11,932
Carrying costs
Bad debts
Profit before taxes
4,068
7,890 (3,822)
11,000
20,000 (9000)
$246,864 $222,110 $24,754
Taxes (40%)
Net income
98,745
88,844
9,902
$148,118 $133,266 $14,852
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
35
Sensitivity Analysis of Change
Assume the firm makes the policy
change, but its competitors react by
making similar changes. As a result,
gross sales remain at $1,000,000. How
does this impact the firm’s after-tax
profitability?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
36
Impact of Change on Net
Income
Gross sales
Less: discounts
Net sales
Production costs
Pre-tax op. profit
Carrying costs
Bad debt losses
Profit before taxes
Taxes
Net Income
$1,000,000
11,880
$988,120
750,000
$238,120
3,699
10,000
$ 224,421
89,769
$ 134,653
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37
Net Effect of the Change
Before the new policy change, the firm’s
net income totaled $133,266.
The change would result in a slight gain
of $134,653 – $133,266 = $1,387.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
38
Cost of Bank Loans: $100,000
at 8% Quoted Rate, 1 Year
What is the EAR for a loan with:
Simple annual interest.
Discount interest.
Discount interest with 10% compensating balance.
Installment loan, add-on, 12 months.
What is the EAR for the first 3 loans if interest
is compounded quarterly?
How much must be borrowed to get
$100,000 of usable funds at origination?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
39
Why must we use Effective Annual
Rates (EARs) to evaluate the loans?
Each loan has an 8% nominal (quoted)
rate, but:
We want to compare loan cost rates and
choose the alternative with the lowest cost.
Because the loans have different terms, we
must make the comparison on the basis of
EARs.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website …
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