Question 1

Ajax predicts that if a customer pays on the first sale, it is assured that it is a reliable customer.As such, it expects that customer to generate a net profit of $350 per year for 12 years.Ajax calculates present value with a 15% rate of return.There is a 90% probability that Ajax will secure a reliable customer.However, if the customer defaults, Ajax will have to incur a loss of $500.Determine the expected benefit if credit is granted.

Accepted Answer

The expected benefit is calculated as: (0.9 x $1,897) - (0.1 x $500) = $1,707 - $50 = $1,657.

Question 2

Which of the following is the least expensive source of credit information?

Accepted Answer

Bond ratings are generally the least expensive source of credit information because they are often freely available to the public through various financial news outlets, websites, and the issuing entities themselves. In contrast, detailed reports from Dun & Bradstreet, Moody's, and Standard & Poor's typically require a subscription or purchase.

Question 3

Universal Corporation is concerned about their current bad debt ratio of 6%.The CFO believes imposing a more stringent credit policy may reduce sales by 5% and reduce the bad debt ratio to 4%.If the cost of goods sold is 80% of the selling price, determine if the new policy should be undertaken.

Accepted Answer

Under the current policy, for every $100 in sales, the cost of goods sold (COGS) is $80, leaving a gross profit of $20. However, with a bad debt ratio of 6%, the actual profit is reduced by $6 (6% of $100), leaving a net profit of $14. Under the new policy, sales would decrease to $95, and with a COGS of 80%, the gross profit on these sales would be $19. The bad debt ratio would also decrease to 4%, reducing the profit by $3.8 (4% of $95), leaving a net profit of $15.2. The increase in profit from $14 to $15.2 represents an increase of $1.2 on the original $14, which is an increase of approximately 8.57%.

Question 4

You are buying goods worth $75,000 from a firm that offers the credit terms of 2/10, net 30.What will be the actual payment if you paid within 10 days?

Accepted Answer

The credit terms 2/10, net 30 mean a 2% discount is available if payment is made within 10 days. Therefore, the discount is $75,000 x 0.02 = $1,500, making the payment $75,000 - $1,500 = $73,500.

Question 5

Which of the following credit agreements provides the maximum protection to the seller?

Accepted Answer

Banker's acceptance provides the maximum protection to the seller because it is a draft drawn on a bank and accepted by the bank, which guarantees payment to the seller.

Question 6

A breakdown of accounts receivable according to the length of time outstanding is known as a(n):

Accepted Answer

An aging schedule is a report that breaks down a company's accounts receivables by the length of time they have been outstanding. This allows the company to see which customers are consistently taking a long time to pay and take appropriate action, such as sending payment reminders or even discontinuing doing business with them. A, B, and C are not correct answers as they do not relate to the breakdown of accounts receivable by the length of time outstanding.

Question 7

Which of the following assumptions is made when declaring that the break-even probability of collection is lower for customers with repeat orders?

Accepted Answer

The assumption made is that payment on the first order ensures payments on subsequent orders, as the customer has already established a reliable payment history. This reduces the risk of non-payment and therefore lowers the break-even probability of collection. None of the other options listed are directly related to this assumption.

Question 8

Jomal Corporation expects to receive $2,300 along with costs of $1,800 on each non-delinquent sale on credit.The probability of collection is 85%.Determine whether credit should be extended.

Accepted Answer

The expected net benefit is calculated as: 0.85 * ($2,300 - $1,800) - 0.15 * $1,800 = $155. Since the net benefit is positive, credit should be extended.

Question 9

Xian Corporation predicts that if a customer pays on the first sale, it is assured that it is a reliable customer.As such, it expects that customer to generate a net profit of $700 per year for 10 years.Ajax calculates present value with a 9% rate of return.There is a 70% probability that Ajax will secure a reliable customer.However, if the customer defaults, Ajax will have to incur a loss of $800.Determine the expected benefit if credit is granted.

Accepted Answer

Using the formula:
Expected benefit = P x PV(REV - COST) - (1-p) x PV(COST)
= 0.7 x ($4,492 - $0) - 0.3 x ($800)
= $3,144 - $240
= $2,904
Therefore, the expected benefit if credit is granted is $2,904, which corresponds to option B.

Question 10

Should credit be granted to a customer wishing to purchase a $2,000 item that has been marked-up 50% over cost if the probability of collection is only 65%? Assume all cash flows are discounted to present value.

Accepted Answer

The expected loss calculation shows that there is a higher probability of loss than profit, therefore granting credit in this situation would not be advisable. The expected loss is $33.33, meaning that on average, for every $2,000 item sold, the company can expect to lose $33.33.

Question 11

What is the minimum probability of collection that should be accepted by firms that have a 25% profit margin? Ignore the time value of money.

Accepted Answer

The break-even probability of collection is calculated by setting the profit margin equal to the expected loss from non-collection. With a 25% profit margin, the firm needs at least a 75% probability of collection to break even, as shown by the equation: 0.25 = 0.75 * (1 - x), solving for x gives x = 0.75 or 75%.

Question 12

What is the effective annual rate of trade credit if the trade credit terms are 1/10, net 30?

Accepted Answer

The effective annual rate of trade credit can be calculated using the formula: [(1 + discount/1 - discount)^(365/days past discount) - 1]. For 1/10, net 30 terms, it is [(1 + 0.01/0.99)^(365/20) - 1] = 20.13%.

Question 13

A firm with ______ profit margin should extend credit to customers with a high probability of default.

Accepted Answer

A firm with a high profit margin can better absorb the losses associated with extending credit to customers who may default, compared to firms with lower profit margins.

Question 14

Which of the following financial ratios has the highest weight in Altman's Z score estimation?

Accepted Answer

Altman's Z score model uses five financial ratios: working capital/total assets, retained earnings/total assets, EBIT/total assets, sales/total assets, and book value of equity/total liabilities. However, EBIT/total assets has the highest weight in the Z score estimation, making it the most important ratio in determining a company's financial health according to this model.

Question 15

Which of the following credit decisions appears correct for a customer that intends to order $1,000 of goods annually that have a 20% profit margin if the probability of default is 20% and the discount rate is 10%?

Accepted Answer

Expected profit = (p x PV of profit) - (1 - p) x cost= )8 x ($200/.10) - (1 - .8) x $800= $1,600 - $160= $1,440

Question 16

What is the break-even probability of collection when the present value of revenues from a sale is $100,000 and the present value of cost is $87,000?

Accepted Answer

The break-even probability of collection is the probability at which the present value of expected revenues equals the present value of expected cost. 
Break-even probability of collection = (present value of cost)/(present value of revenues + present value of cost) = $87,000 / ($100,000 + $87,000) = 0.4667 or 46.67%
Therefore, the probability of collection needs to be at least 46.67% or 0.4667 for the project to break even. 
The closest choice to this value is B, which is 0.87. Thus, the best choice is B.

Question 17

Assuming that a credit decision has been analyzed and credit refused due to a negative expected profit, which of the following changes, if of sufficient magnitude, might change the decision to one of approval?

Accepted Answer

Increasing the profit margin would directly increase the expected profit, which could make the credit decision profitable and change it to one of approval. Decreasing the probability of payment, increasing the discount rate, or reducing the expected profit would all lead to a further decrease in expected profit, thus reinforcing the initial decision to refuse credit.

Question 18

A firm is considering a one-time sale of $100,000 to a customer.The cost of goods sold for this sale is $90,000.If the probability of the customer paying is 0.8, what is the expected profit from this transaction?

Accepted Answer

The answer of A firm is considering a one-time sale...

Question 19

Samana Corporation expects to receive $1,500 along with costs of $1,000 on each non-delinquent sale on credit.The probability of collection is 60%.Determine whether credit should be extended.

Accepted Answer

The answer of Samana Corporation expects to receive $1,500 along...

Question 20

A retailer buys Christmas merchandize from the manufacturer on Sep.1.The manufacturer postdates the invoice to Dec.31, and the credit terms of the sale are 2/10, net 30.When is the payment due?

Accepted Answer

The payment is due 30 days from the postdate, which is Dec.31. Thus, the payment is due on Jan.30.

Quiz 22: International Financial Management