2 Assignments. 2 no later than Wednesday afternoon

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!
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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
© 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.
2
Topics in Chapter
?
Receivables management
?
?
?
?
?
Credit policy
Days sales outstanding (DSO)
Aging schedules
Payments pattern approach
Cost of bank loans
© 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.
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…)
© 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.
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.
© 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.
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.
© 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.
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.
© 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.
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
© 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.
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.
© 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.
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.
© 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.
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.
© 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.
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
© 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.
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
© 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.
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
© 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.
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.
© 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.
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%
© 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.
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
© 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.
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…)
© 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.
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.
© 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.
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?
© 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.
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
© 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.
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
© 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.
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.
© 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.
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.
© 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.
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
© 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.
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
© 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.
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?
© 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.
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
© 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.
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.
© 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.
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?
© 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.
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.
© 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 …
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