Deck 22: Credit Management and Collection

Question 1

Ignoring the time value of money,how much does a firm lose on a $2,000 sale that has a 30% profit margin if the 20% probability of default occurs?

A) $120
B) $280
C) $600
D) $1,400

Answer 1

$1,400

Question 2

Bond ratings are an inexpensive source of credit information on publicly traded companies.

Answer 2

True

Question 3

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?

A) $73,500
B) $74,250
C) $75,000
D) $76,500

Answer 3

$73,500

Question 4

A firm offered 3/10,net 30 as terms of trade credit on a $1,000 invoice dated January 1.How much must the purchaser offer to pay in full on January 4^th?

A) $970.00
B) $971.16
C) $1,000.00
D) $1,030.00

Question 5

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?

A) Zero
B) -$10,000
C) +$8,000
D) +$10,000

Question 6

Commercial drafts are issued by a customer's bank.

Question 7

The "five C's of credit" represent a framework for analyzing credit risk.

Question 8

Profits are maximized in a firm when the number of bad accounts is minimized.

Question 9

A customer who ignores the cash discount but pays within the payment period need not add interest to the invoice.

Question 10

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.

A) $1,657
B) $1,757
C) $1,857
D) $1,957

Question 11

Credit analysis is a procedure used to determine the implied cost of trade credit.

Question 12

A higher score in a typical questionnaire for credit scoring analysis indicates a higher creditworthiness.

Question 13

An aging schedule is a statement sent to customers who are behind in payments.

Question 14

The break-even probability of collection is positively related to the firm's percentage of profit margin.

Question 15

Extending trade credit can increase the probability of repeat orders.

Question 16

Since defaults can be costly,it is cost effective to undertake a full credit analysis of all customers.

Question 17

Progress payments allow the customers to choose the payment schedule.

Question 18

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.

A) $2,804
B) $2,904
C) $3,004
D) $3,104

Question 19

The potential benefits of additional credit analysis should always be weighed against the incremental costs.

Question 20

The more liberal the terms of the collection policy,the less the potential for bad debts and unprofitable sales.

Question 21

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

A) 13.01%
B) 18.00%
C) 18.43%
D) 20.13%

Question 22

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%?

A) Reject because expected loss equals $320
B) Reject because expected profit equals $0
C) Accept because expected profit equals $1,440
D) Accept because expected profit equals $3,200

Question 23

When sellers deliberately postdate an invoice by several months,their terms of sale include:

A) COD
B) EOM
C) CBD
D) Season dating

Question 24

What effective interest rate is charged to a purchaser receiving terms of 5/10,net 90 if the purchaser avoids the discount and pays in 90 days?

A) 20.00%
B) 22.81%
C) 24.93%
D) 26.37%

Question 25

Which of the following terms of sale is the most restrictive?

A) Net 30
B) Seasonal dating
C) CBD
D) COD

Question 26

With terms of 4/15,net 60,what is the implied interest rate for forgoing a cash discount and paying at the end of the period?

A) 25.63%
B) 28.19%
C) 39.25%
D) 61.15%

Question 27

Which statement is true about terms of trade credit of 2/10,net 30?

A) A 10% cash discount is offered for payment before 30 days
B) A 2% cash discount can be taken for payment before the 10^th of the following month
C) A 10% cash discount can be taken if paid by the second day after invoicing
D) No cash discount is offered after the eleventh day

Question 28

The Five C's of Credit refer to the:

A) Credit reports issued by Dun & Bradstreet
B) Interpretation of numerical credit scoring systems
C) Attributes that help determine creditworthiness
D) Financial ratios used to determine Altman's Z score

Question 29

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?

A) 1.00
B) 0.87
C) 0.74
D) 0.13

Question 30

Before spilling coffee on an invoice and obliterating the final due date,you calculate the implied interest cost of trade credit at 24.89% and remember there is a 3% cash discount if paid within 10 days.When is the due date?

A) 30 days
B) 45 days
C) 50 days
D) 90 days

Question 31

Determine the annual effective rate of a customer that does not take advantage of credit terms of 2/10,n/30.

A) 38.59%
B) 40.59%
C) 42.59%
D) 44.59%

Question 32

At what point does a customer's unpaid account become delinquent when the terms of sale are 2/10,net 60?

A) 11 days after the sale
B) 31 days after the sale
C) 61 days after the sale
D) 71 days after the sale

Question 33

Determine the annual effective rate of a customer that does not take advantage of credit terms of 3/15,n/30.

A) 109.84%
B) 69.84%
C) 29.84%
D) 9.84%

Question 34

Which of the following elements of credit terms might discourage purchasers from paying with a discount?

A) A higher discount percentage with shorter payment period.
B) A shorter payment period with longer discount period.
C) A longer discount period with higher discount percentage
D) A longer payment period with lower discount period.

Question 35

Which of the following would not be included in the five C's of credit?

A) Character
B) Condition
C) Charges
D) Capital

Question 36

Which of the following would be least expected to change as a result of a higher average age of receivables?

A) Current ratio
B) Total collection costs
C) Accounts payable
D) Bad debt expense

Question 37

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.

A) 20%
B) 25%
C) 50%
D) 75%

Question 38

An accepted time draft is quite similar to:

A) Selling on open account
B) A conditional sale
C) A cheque dated in the future
D) An overdue account

Question 39

Which of the following would not be a customary source of credit information on customers?

A) Dun & Bradstreet
B) Canada Customs and Revenue Agency
C) Credit Bureau
D) Customer's bank

Question 40

What is the break-even probability of collection for a firm that has a 40% profit margin (ignore present value)?

A) 24%
B) 40%
C) 60%
D) 80%

Question 41

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?

A) Jan. 10
B) Jan. 30
C) Feb. 10
D) Sep. 30

Question 42

SamanaCorporation 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.

A) Extend credit - net benefit of $100
B) Extend credit - net benefit of $0
C) Do not extend credit - net detriment of $100
D) Do not extend credit - net detriment of $200

Question 43

JomalCorporation 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.

A) Extend credit - net benefit of $155
B) Extend credit - net benefit of $80
C) Do not extend credit - net detriment of $155
D) Do not extend credit - net detriment of $80

Question 44

Which of the following is not likely to be a characteristic of a numerical credit scoring system?

A) Used to prescreen credit applications
B) Used shareholders' income tax returns
C) Less subjective than using individual loan officers
D) Most appropriate for consumer loans

Question 45

Select the earliest date below which does not deserve a cash discount if the terms of a January 1 sale are 2/10,EOM,net 60?

A) January 2
B) January 12
C) February 2
D) February 12

Question 46

Credit scoring systems can be used to:

A) Reduce the effective cost of trade
B) Determine the cost of goods sold
C) Evaluate Dun & Bradstreet's reports
D) Evaluate credit risk based on the borrower's characteristics

Question 47

Balsam Corporation is concerned about their current bad debt ratio of 9%.The CFO believes imposing a more stringent credit policy may reduce sales by 8% and reduce the bad debt ratio to 6%.If the cost of goods sold is 85% of the selling price,determine if the new policy should be undertaken.

A) Undertake; increase of 40% in profits
B) Undertake; increase of 38% in profits
C) Do not undertake; decrease of 36% in profits
D) Do not undertake; decrease of 34% in profits

Question 48

Saxon Corporation sells a product for $48 with costs of $33 per unit.Saxon uses a 9% rate of return for all its calculations.The CFO estimates that there is a 20% probability of a prospective new customers seeking credit will go bankrupt within the next 6 months.Customer wishes to place an order for 1,000 units of the product.

A) Extend credit; total benefit of $3,780
B) Extend credit; total benefit of $3,880
C) Extend credit; total benefit of $3,980
D) Extend credit; total benefit of $4,080

Question 49

Candy Corporation sells a product for $25 with costs of $20 per unit.Candy uses a 12% rate of return for all its calculations.The CFO estimates that there is a 25% probability of a prospective new customers seeking credit will go bankrupt within the next 6 months.Customer wishes to place an order for 2,500 units of the product

A) Extend credit; total benefit of $5,300
B) Extend credit; total benefit of $5,500
C) Do not extend credit; total loss of $5,300
D) Do not extend credit; total loss of $5,500

Question 50

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

A) Working capital/total assets
B) Retained earnings/total assets
C) EBIT/total assets
D) Sales/total assets

Question 51

A purchaser was offered terms of trade credit of 2/10,net 30,with an invoice date of January 1.Which one of the following acts threatens creditworthiness?

A) Taking the discount, paying on January 5.
B) Taking the discount, paying on January 10.
C) Ignoring the discount, paying on January 30.
D) Ignoring the discount, paying on February 9.

Question 52

Under the terms of a sight draft,the buyer's bank:

A) Is instructed to make immediate payment
B) Treats the invoice like a postdated cheques
C) Forwards the acceptance to the seller until due
D) Treats the purchase as a conditional sale

Question 53

Higher Z scores from a multiple discriminate analysis indicate a:

A) Higher risk of bankruptcy
B) Lower degree of creditworthiness
C) Lower amount of working capital
D) Higher degree of solvency

Question 54

Which of the following financial ratios is not used to develop Altman's Z score from multiple discriminate analysis?

A) Market value of equity/book debt
B) EBIT/total assets
C) Interest expense/total assets
D) Working capital/total assets

Question 55

Which of the following strategies would continue to be effective if a cash-strapped firm determines that the effective interest rate charged on trade credit is lower than the bank's interest rate?

A) Take the discount but pay after the discount period.
B) Borrow from the bank and take the discount.
C) Ignore the discount, pay at the end of the period.
D) Take the discount and hope for longer payment float.

Question 56

The set of rules that determines whether or not to extend credit is known as:

A) Credit analysis
B) Credit policy
C) Multiple discriminate analysis
D) The terms of trade credit

Question 57

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

A) High
B) Average
C) Low
D) Zero

Question 58

Which of the following changes to the terms of credit would make the effective annual rate increase?

A) Increase the cash discount percentage
B) Extend the discount period
C) Extend the payment period
D) All of these changes will increase the effective rate

Question 59

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?

A) Increase the percentage of profit margin
B) Decrease the probability of payment
C) Increase the discount rate
D) Reduce the expected profit

Question 60

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.

A) Undertake; increase of 8.57% in profits
B) Undertake; increase of 9.55% in profits
C) Do not undertake; decrease of 8.57% in profits
D) Do not undertake; decrease of 9.55% in profits

Question 61

When sales are made without the accompaniment of a formal debt contract,the sales are said to be on:

A) Conditional sale terms
B) Open account
C) Trade credit
D) Sight draft

Question 62

What happens to the implied interest rate on trade credit as the time interval between the discount period and payment period is decreased?

A) The rate declines
B) The rate increases
C) The rate remains constant
D) Impossible to predict without knowing length of discount period

Question 63

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

A) Banker's acceptance
B) Conditional sale
C) Open account
D) Commercial draft

Question 64

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

A) Amortization schedule
B) Sources of cash flow statement
C) Receivables inventory
D) Aging schedule

Question 65

Would it ever make financial sense to forgo cash discounts that are offered from suppliers? Can you provide an example?

Question 66

Why will sellers be less reluctant to grant credit under terms of a banker's acceptance? How do the acceptances work,in general?

Question 67

Which of the following statements is correct about banker's acceptances?

A) They are equivalent to a sight draft
B) They represent the norm for installment sales
C) The bank guarantees payment of the invoice
D) The bank retains title to the merchandise

Question 68

Which of the following statements is typically correct concerning the break-even probability of collection for repeat sale customers?

A) Break-even probability is higher than for single sale customers.
B) Break-even probability is lower than for single sale customers.
C) The break-even probability does not change between single sale and repeat sale customers.
D) Sales should never be refused for customers offering the potential of repeat sales.

Question 69

An aging schedule illustrates the relationship between:

A) Customers and repeat sales
B) Sales and profitability
C) The ratio of accounts receivable to sales
D) Accounts receivable and their average time outstanding

Question 70

Which of the following credit agreements will provide the highest likelihood of cash payment to a seller of goods?

A) Banker's acceptance
B) Time draft
C) Open account
D) Conditional sale

Question 71

Which of the following is correct concerning terms of trade credit of 4/10,EOM,net 90?

A) The discount period expires on the last day of the month.
B) The invoice becomes delinquent 90 days after the last day of the month.
C) The discount period ends on the tenth day of the month following the invoice.
D) The discount period ends either 10 days after invoicing or at the end of the month, whichever is earlier.

Question 72

What credit decision is appropriate for a potential customer that offers an 80% chance of paying on a $10,000 (present value)sale that has an 80% (present value)cost?

A) Grant credit since expected profit is $3,200
B) Grant credit since expected profit is $800
C) Refuse credit since expected profit is zero
D) Refuse credit since expected loss is $3,000

Question 73

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

A) Dun & Bradstreet
B) Moody's
C) Standard & Poor's
D) Bond ratings

Question 74

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

A) The discount rate is fairly high
B) The cost of the item will continually decline
C) The sales price of the item will continually increase
D) Payment on the first order insures payments on subsequent orders

Question 75

According to credit experts,a full credit analysis should be conducted:

A) On each customer of a firm
B) Only when payment is doubtful
C) Only on customers that are delinquent
D) On all repeat customers

Question 76

Which of the following typically justifies the offering of season dating?

A) The firm earns interest on the receivables
B) Product demand is increased during the low-sales months of the year
C) The firm is experiencing cash flow difficulties
D) The firm develops repeat business

Question 77

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.

A) No; the expected loss is $33.33
B) No; the expected loss is $150.00
C) Yes; the expected profit is $33.33
D) Yes; the expected profit is $150.00

Question 78

The purpose of credit analysis is to:

A) Reconcile the accounts receivable balance
B) Modify the terms of trade credit
C) Organize the right side of the balance sheet
D) Decide whether or not to grant credit to a customer

Question 79

It may be possible for firms to reduce the time and expense necessary to collect delinquent debts under a(n):

A) Promissory note
B) Conditional sale
C) Open account
D) EOM billing

Question 80

In general,a firm's credit policy should grant the credit whenever the expected:

A) Loss from default is less than the cost of the product.
B) Profit from granting credit exceeds zero.
C) Profit exceeds the price of the product.
D) Probability of a loss is less than 50%.