P17-1: What are the nominal and effective costs of trade credit under the credit terms of 3/15,
net 30?
= 0.0309 24.33 = 0.7526 = 75.26%.
Effective cost of trade credit = (1.0309) 24.33 – 1.0 = 1.0984 = 109.84%.
P17-4: Griswall Industries sells on terms of 2/10, net 45. Total sales for the year are $1,500,000. Thirty percent
of the customers pay on the 10th day and take discounts; the other 70% pay, on average, 50 days after their
purchases.
a) What is the days’ sales outstanding?
b) What is the average amount of receivables?
c) What would be the new days’ sales outstanding and average receivables if Griswall toughened its collection
policy with the result that all nondiscount customers paid on the 45th day?
a)
b)
c) (DSO is lower, so freed up cash)
P17-8: Sterling Enterprises has an inventory conversion period of 50 days, an average collection period of 35
days, and a payables deferral period of 25 days. Assume that cost of goods sold is 80% of sales.
a) What is the length of the firm’s cash conversion cycle?
b) If Sterling’s annual sales are $4,380,000 and all sales are on credit, what is the firm’s investment in accounts
receivable?
c) How many times per year does Sterling Enterprises turn over its inventory?
a)
b)
c)
Alternatively:
P17-11: Burman Hardware is negotiating with First City Bank for a 1-year loan of $50,000. First City has offered Burman
the following alternatives. Calculate the effective annual interest rate for each alternative. Which alternative has the
lowest effective annual interest rate?
a) A 12% annual rate on a simple interest loan with interest due at the end of the year.
b) An 8.75% annual rate on a discounted loan.
c) Interest is figured as 8% of the $50,000 amount, payable at the end of the year, but the $50,000 is repayable in
monthly installments during the year.
a) C/Y =1, P/Y = 1; N = 1; PMT = 0; PV = +50,000; FV = -50,000 – 0.12(50,000) = -56,000
CPT I/Y = 12%
b) C/Y =1, P/Y = 1; N = 1; PMT = 0;
PV = 50,000/ (1-0.0875) – 0.0875(50,000/ (1-0.0875)) = +54,794.52 – 4,794.52 = +50,000;
-Bank lends you $54,794.52 but withholds at time 0 interest of $4,794.52. So you end up receiving net $50,000.
FV = -54,794.52 (pay back the full amount)
CPT I/Y = 9.59%
c) C/Y =1, P/Y = 12; N = 12; PMT = -50,000/12 = -4,166.67; PV = +50,000; FV = -0.08(50,000)= -4,000
CPT I/Y = 14.47%
The cheapest alternative is b) the discount loan.
P17-14: Madison Walter recently leased space in the Northside Mall and opened a new business, Madison’s
Florist. Business has been good, but Madison has frequently run out of cash. This has necessitated late
payment on certain orders, which, in turn, is beginning to cause a problem with suppliers. Madison plans to
borrow from the bank to have cash ready as needed, but first she needs a forecast of just how much she must
borrow. Accordingly, she has asked you to prepare a cash budget for the critical period around Christmas, when
needs will be especially high.
Sales are made on a cash basis only. Madison’s purchases must be paid for during the following month.
Madison pays herself a salary of $6,000 per month, and the rent is $3,000 per month. In addition, she must
make a tax payment of $9,000 in December. The current cash on hand (on December 1) is $800, but Madison
has agreed to maintain an average bank balance of $2,000—this is her target cash balance. (Disregard till cash,
which is insignificant because Madison keeps only a small amount on hand in order to lessen the chances of
robbery.)
The estimated sales and purchases for December, January, and February are shown below. Purchases during
November amounted to $140,000.
Will cover in MT review
Sales Purchases
December $160,000 $40,000
January 42,000 $40,000
February 50,000 $30,000
a) Prepare a cash budget for December, January, and February.
b) Now, suppose Madison were to start selling on a credit basis on December 1, giving customers 30 days to
pay. All customers accept these terms, and all other facts in the problem are unchanged. What would the
company’s loan requirements be at the end of December in this case?
Will cover in MT review
P17-21: Rusty Spears, CEO of Rusty’s Renovations, a custom building and repair company, is preparing
documentation for a line of credit request from his commercial banker. Among the required documents is a
detailed sales forecast for parts of 2021 and 2022:
Will cover in MT review
Estimates obtained from the credit and collection department are as follows: collections within the month of
sale, 15%; collections during the month following the sale, 65%; collections the second month following the
sale, 20%. Payments for labour and raw materials are typically made during the month following the one in
which these costs were incurred. Total costs for labour and raw materials are estimated for each month as
shown in the table.
General and administrative salaries will amount to approximately $15,000 a month; lease payments under
long-term lease contracts will be $5,000 a month; depreciation charges will be $7,500 a month; miscellaneous
expenses will be $2,000 a month; income tax payments of $25,000 will be due in both September and
December; and a progress payment of $80,000 on a new office suite must be paid in October. Cash on hand on
July 1 will amount to $60,000, and a minimum cash balance of $40,000 will be maintained throughout the cash
budget period.
Will cover in MT review