Question 1

Newsome Inc.buys on terms of 3/15, net 45.It does not take the discount, and it generally pays after 60 days.What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?

Accepted Answer

The nominal annual percentage cost of non-free trade credit is calculated as follows:Nominal Annual Percentage Cost = (Discount Percentage / (1 - Discount Percentage)) * (365 / Net Period - Discount Period)= (3% / (1 - 3%)) * (365 / 45 - 15)= (3% / 0.97) * (365 / 30)= 0.0309 * 12.17= 0.377 or 37.7%

Question 2

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

Taylor Textbooks Inc. pays on time, 50 days after the invoice date. So, the firm receives 50 days of free credit. The firm does not take discounts, so the total credit is 50 days. Therefore, the dollar amount of costly trade credit is $450,000 * (50/365) = $43,151.

Question 3

Freeman Builders, Inc.buys on terms of 2/15, net 30.It does not take discounts, and it typically pays 60 days after the invoice date.Net purchases amount to $720,000 per year.What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?

Accepted Answer

The nominal annual percentage cost of not taking the discount can be calculated using the formula: [(Discount % / (1 - Discount %)) * (365 / (Full Payment Due Date - Discount Period))]. Plugging in the values: [(2% / (1 - 2%)) * (365 / (60 - 15))] = 16.55%.

Question 4

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

The answer of Suppose the suppliers of your firm offered...

Question 5

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

The effective annual percentage cost of forgoing the discount can be calculated using the formula: (Discount % / (1 - Discount %)) * (365 / (Payment Days - Discount Days)). Substituting the given values: (1% / (1 - 1%)) * (365 / (40 - 10)) = 13.01%.

Question 6

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

The correct answer is A.The maximum dollar amount of costly trade credit the firm could get is $53,699. This is calculated as follows:Gross purchases = $800,000Discount period = 15 daysNet period = 40 daysDays in a year = 365 daysAverage payment period = (Discount period + Net period) / 2= (15 days + 40 days) / 2= 27.5 daysCostly trade credit = Gross purchases * (Average payment period / Days in a year) * Discount rate= $800,000 * (27.5 days / 365 days) * 2%= $53,699

Question 7

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

The firm receives trade credit for 60 days, and its average accounts payable are equal to 60/365 * $550,000 = $90,411.

Question 8

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

The formula for calculating the free trade credit is:

Discount period / (1 - Discount %) - Discount period

Discount period = 15 days
Discount % = 2/100 = 0.02

Free trade credit = (15 / (1 - 0.02) - 15) x (Net purchases / 365)
Free trade credit = $18,493.15

Question 9

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

Accepted Answer

Stretching accounts payable, even for a profitable firm, indicates a cash flow issue, suggesting the firm does not have enough working capital to comfortably meet its short-term obligations, thus pointing to undercapitalization.

Question 10

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

The firm's average accounts payable balance is calculated by considering the cost of not taking the discount. The discount offered is 2/10 net 30, meaning if the payment is made within 10 days, a 2% discount is available; otherwise, the full amount is due in 30 days. Since the firm pays on the 30th day, it foregoes the discount, effectively borrowing $375,000 at a cost of 2% for 20 days (the difference between paying on the 10th day and the 30th day). To annualize this, we calculate the equivalent annual cost of this borrowing. The formula to find the average accounts payable balance, considering the firm is effectively paying an interest for not taking the discount, is:$$ \text{Average Accounts Payable} = \text{Costly Trade Credit} \times \left(1 + \frac{\text{Discount Percentage}}{1 - \text{Discount Percentage}} \times \frac{\text{Days in Year}}{\text{Discount Period} - \text{Net Period}}\right) $$Given:- Costly Trade Credit = $375,000- Discount Percentage = 2% or 0.02- Days in Year = 365- Discount Period = 10 days- Net Period = 30 daysPlugging the values into the formula:$$ \text{Average Accounts Payable} = 375,000 \times \left(1 + \frac{0.02}{1 - 0.02} \times \frac{365}{20}\right) $$$$ \text{Average Accounts Payable} = 375,000 \times \left(1 + \frac{0.02}{0.98} \times 18.25\right) $$$$ \text{Average Accounts Payable} = 375,000 \times \left(1 + 0.372959 \right) $$$$ \text{Average Accounts Payable} = 375,000 \times 1.372959 $$$$ \text{Average Accounts Payable} \approx 515,109.625 $$However, since this specific calculation does not match any of the provided options and the premise of the calculation was to illustrate the method, it seems there was a misunderstanding in the approach. The correct approach should focus on understanding that the costly trade credit represents the additional cost due to not taking the discount, and the average accounts payable balance would be higher than the costly trade credit due to the opportunity cost of not taking the discount. Given the options and the context, the correct answer should reflect the cost of foregoing the discount over the year, which would typically result in a higher payable balance than the base amount of costly trade credit. However, without the precise calculation matching the options, the explanation aimed to demonstrate the thought process behind calculating the impact of trade credit terms on accounts payable. The correct answer, based on the options provided and assuming a direct relationship between the costly trade credit and the average accounts payable balance that reflects a typical scenario of not taking early payment discounts, would ideally be chosen to reflect the understanding of these financial dynamics. Given the misunderstanding in the calculation, let's correct the approach:The correct approach involves understanding that the costly trade credit is a part of the average accounts payable balance, but without the exact formula or calculation directly leading to the options provided, the focus should be on the principles behind trade credit and its cost implications. The explanation aimed to navigate through these principles, albeit the final calculation did not align with the provided choices, indicating a need for recalibration in the calculation or a reevaluation of the assumptions made.

Question 11

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

The effective annual percentage cost of non-free trade credit can be calculated using the following formula:

Effective Annual Percentage Cost = [(Discount %) / (1 - Discount %)] x [365 / (Days credit is taken - Discount period)]

Where,
Discount % = 2%
Days credit is taken = 45 days
Discount period = 8 days

Substituting the values in the formula, we get:

Effective Annual Percentage Cost = [(2%) / (1 - 2%)] x [365 / (45 - 8)]
= 0.0204 x 10.1096
= 0.2064 or 20.64%

However, since Andrews Corporation does not take discounts, we need to calculate the effective annual percentage cost without considering the discount. In this case, the effective annual percentage cost can be calculated using the following formula:

Effective Annual Percentage Cost = [(Discount %) / (1 - Discount %)] x [365 / (Days credit is taken - Discount period + Discount period x (Discount %))]

Substituting the values in the formula, we get:

Effective Annual Percentage Cost = [(2%) / (1 - 2%)] x [365 / (45 - 8 + 8 x 2%)]
= 0.0204 x 9.76
= 0.1991 or 19.91%

Therefore, the effective annual percentage cost of Andrews Corporation's non-free trade credit is 19.91%. The best choice is C.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10 days of free trade credit.

Question 13

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Accepted Answer

Stretching accounts payable means delaying payment to the supplier past the agreed-upon payment terms, which can create a disruption in the supplier's cash flow and increase their financial costs such as interest expenses or uncollected fees. Therefore, stretching accounts payable can represent a real financial cost to the supplier.

Question 14

Shorter-term cash budgets⎯say a daily cash budget for the next month⎯are generally used for actual cash control while longer-term cash budgets⎯say monthly cash budgets for the next year⎯are generally used for planning purposes.

Accepted Answer

Shorter-term cash budgets are used for actual cash control, while longer-term cash budgets are used for planning purposes.

Question 15

The company you just started has been offered credit terms of 4/30, net 90 days.What will be the nominal annual percentage cost of its non-free trade credit if it pays 120 days after the purchase? (Assume a 365-day year.)

Accepted Answer

The nominal annual percentage cost of the non-free trade credit can be calculated using the formula for the cost of not taking the discount and extending the payment beyond the discount period. The formula is: $$Cost = \left(\frac{Discount\%}{1 - Discount\%}\right) \times \left(\frac{365}{Days\ beyond\ discount\ period}\right)$$ Given the terms 4/30, net 90, and the company pays in 120 days, the discount is 4%, and the days beyond the discount period are 120 - 30 = 90 days. Plugging these values into the formula: $$Cost = \left(\frac{0.04}{1 - 0.04}\right) \times \left(\frac{365}{90}\right) = 0.041666667 \times 4.05555556 = 0.1690\ or\ 16.90\%$$

Question 16

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

The answer of Howes Inc.purchases $4,562,500 in goods per year...

Question 17

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

Accepted Answer

If a firm assumes cash flows occur uniformly but actually experiences concentrated payments at the beginning of the month, its peak borrowing needs may be understated, not overstated, because it might not account for the immediate cash outflow at the month's start.

Question 18

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 25%.If the firm implements the plan, what is the expected change in net income?

Accepted Answer

The expected change in net income can be calculated by first determining the savings from taking the discounts, then subtracting the cost of borrowing to take those discounts, and finally adjusting for the effect of taxes. Savings from discounts: $11,760 * 0.02 * 365 = $85,584. Cost of borrowing: $11,760 * 0.98 * 365 * 0.10 = $42,524. Pre-tax income increase: $85,584 - $42,524 = $43,060. After-tax income increase: $43,060 * (1 - 0.25) = $32,295. The correct answer is not directly listed because the calculation provided leads to a different result than the options given, indicating a possible mistake in the calculation steps or misunderstanding of the question's requirements. The correct approach involves calculating the daily savings from taking discounts, the annual cost of borrowing to finance these discounts, and then adjusting for taxes to find the net change in income.

Question 19

During the coming year, Gold & Gold wants to increase its free cash flow by $180 million, which should result in a higher stock price.The CFO has made these projections for the upcoming year: ∙
EBIT is projected to equal $852 million.
∙
Gross capital expenditures are expected to total to $360 million versus depreciation of $120 million, so its net capital expenditures should total $240 million.
∙
The tax rate is 25%.
∙
There will be no changes in cash or marketable securities, nor will there be any changes in notes payable or accruals.
What increase in net working capital (in millions of dollars) would enable the firm to meet its target increase in FCF?

Accepted Answer

FCF = EBIT * (1 - Tax rate) - Net CapEx - ΔNWC$180 = $852 * (1 - 0.25) - $240 - ΔNWCΔNWC = $219

Question 20

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Accepted Answer

Switching from taking trade credit discounts to paying on the net due date can significantly impact both the income statement and the balance sheet. It can increase the cost of goods sold (due to lost discounts), affecting net income, and alter current liabilities and potentially cash balances on the balance sheet.

Quiz 16: Supply Chains and Working Capital Management