Accounts R Receivable - 4X

McGriff Dog Food Company normally takes 20 days to pay for average daily credit purchases of $9,000. Its average daily sales are $10,000, and it collects accounts in 25 days. a. What is its net credit position? That is, compute its accounts receivable and accounts payable and subtract the latter from the former.

Accounts receivable = Average daily credit sales * Average collection period Accounts payable = Average daily credit purchases * Average payment period b. If the firm extends its average payment period from 20 days to 32 days (and all else remains the same), what is the firm's new net credit position? Has it improved its cash flow?

Solution: McGriff Dog Food Company a. Net credit position = Accounts Receivable – Accounts payable Accounts receivable = average daily * average collection credit sales period $10,000 * 25 = $250,000

Accounts payable = average daily * average payment credit purchases period Payment Period = $9,000 * 20 = $180,000 Net Credit Position = $250,000 – $180,000 = $70,000 b. Accounts Receivable will remain at $250,000 Accounts Payable = $9,000 * 32 = 288,000 Net Credit Position ($ 38,000)

The firm has improved its cash flow position. Instead of extending $70,000 more in credit (funds) than it is receiving, it has reversed the position and is the net recipient of $38,000 in credit. 8-16. Your company plans to borrow $5 million for 12 months, and your banker gives you a stated rate of 14 percent interest. You would like to know the effective rate of interest for the following types of loans. (Each of the following parts stands alone.)

a. Simple 14 percent interest with a 10 percent compensating balance. b. Discounted interest. c. An installment loan (12 payments). d. Discounted interest with a 5 percent compensating balance.

Solution:

a. Simple interest with a 10% compensating balance

$700,000 $700,000 1  15.56% $5,000,000  $500,000 $4,500,000

b. Discounted interest

$700,000 $700,000 1  16.28% $5,000,000  $700,000 $4,300,000

c. An installment loan with 12 payments

212$700,000 $16,800,000   25.85% 13$5,000,000 $65,000,000

d. Discounted interest with a 5% compensating balance

$700,000/($5,000,000 – $700,000 – $250,000) = $700,000/$4,050,000 = 17.28% 8-23)

Summit Record Company is negotiating with two banks for a $100,000 loan.

Fidelity Bank requires a 20 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 10 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 9 percent. Compensating balances will be subtracted from the $100,000 in determining the available funds in part a. a. Which loan should Summit accept? b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains at each bank $20,000 in deposits that will serve as compensating balances. c. Does your choice of banks change if the assumption in part b is correct?

Solution: Summit Record Company a. Fidelity Bank

Effective interest rate 2 4$9,000  $100,000  $20,000  $9,000 4 1  $72,000 / $355,000  20.28%

Southwest Bank

Effective interest rate

212$9,000  $100,000  $10,000 12 1  $216,000 / $1,170,000 18.46% Choose Southwest Bank since it has the lowest effective interest rate. b. The numerators stay the same as in part (a) but the denominator increases to reflect the use of more money because compensating balances are already maintained at both banks.

Fidelity Bank

Effective interest rate = $72,000/($100,000 – $9,000) * 5 = $72,000/$455,000 = 15.82%

Southwest Bank

Effective interest rate = $216,000/($100,000 * 13) = $216,000/$1,300,000 = 16.62% c. Yes. If compensating balances are maintained at both banks in the normal course of business, then Fidelity Bank should be chosen over Southwest Bank. The effective cost of its loan will be less.

Global Services is considering a promotional campaign that will increase annual credit sales by $400,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows: Accounts r receivable - 4x Invenotry - 8x Plant & Equipment - 2x All 400,000 of the sales will be collectible. However, collection costs will be 4% of sales, and production and selling costs will be 76% of sales. The cost to carry inventory will be 8% of inventory. Depreciation expense on plant & equipment will be 5% of plant & equipment. The tax rate is 30%. a. Compute the investments in accounts receivable, inventory, and plant & equipment based on turnover ratios. Add the three together. Investment required in accounts receivable=Increase in sales/Accounts receivable turnover = $400,000 / 4

=$100,000

Investment required in inventory = $400,000 / 8

= $50,000

Investment required in Plant and Equipment

= $400,000/2

= $200,000

Total investment required = $100,000 + $50,000 + $200,000

= $350,000 b. compute the accounts receivable collection costs and production and selling costs and add the two figures together.

Accounts receivable collection costs = $400,000*4%

= $16,000

Production and selling costs = $400,000*76%

= $304,000

Total collection and production costs = $320,000 c. Compute the cost of carrying inventory.

Cost of carrying inventory =8% of investment in inventory

= $50,000*8%

=$4,000 d. Compute the depreciation expense on the new plant & equipment.

Depreciation expanses = 5% of investment in Plant and equipment

= 5%* $200,000 = $10,000 e. add together all the costs in parts, b, c, d.

Total costs = $320,000 + $4,000 + $10,000

=$334,000 f. Subtract the answer from part e from the sales figure of 400,000 to arrive at income before taxes. Subtract taxes at the rate of 30% to arrive at income after taxes.

Income before taxes = $400,000 - $334,000

= $66,000

Income after taxes = $66,000*(1-30%)

= $46,200 g. divide the aftertax return figure in part f by the total investment in part a. If the firm has a required return on investment of 12%, should it undertake the promotional campaign described throughout this problem.

Rate of return = $46,200 / $350,000

= 13.20%

Since the Rate of return is more than required rate of return, the company should take promotional campaign