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CH32 - CHAPTER 32 Credit Management Answers to Practice...

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CHAPTER 32 Credit Management Answers to Practice Questions 1. a. There is a 2% discount if the bill is paid within 30 days of the invoice date; otherwise, the full amount is due within 60 days. b. The full amount is due within 10 days of invoice. c. There is a 2% discount if payment is made within 5 days of the end of the month; otherwise, the full amount is due within 30 days of the invoice date. 2. a. Paying in 60 days (as opposed to 30) is like paying interest of $2 on a $98 loan for 30 days. Therefore, the equivalent annual rate of interest, with compounding, is: 27.86% .2786 0 1 98 100 30) / (365 = = - b. No discount. c. For a purchase made at the end of the month, these terms allow the buyer to take the discount for payments made within five days, or to pay the full amount within thirty days. For these purchases, the interest rate is computed as follows: 34.31% .3431 0 1 98 100 25) / (365 = = - For a purchase made at the beginning of the month, these terms allow the buyer to take the discount for payments made within thirty-five days, or to pay the full amount within thirty days of the purchase. Clearly, under these circumstances, the buyer will take the discount and pay within thirty- five days. The interest rate is negative. 3. When the company sells its goods cash on delivery, for each $100 of sales, costs are $95 and profit is $5. Assume now that customers take the cash discount offered under the new terms. Sales will increase to $104, but after rebating the cash discount, the firm receives: (0.98 × $104) = $101.92 Since customers pay with a ten-day delay, the present value of these sales is: $101.757 1.06 $101.92 (10/365) = Since costs remain unchanged at $95, profit becomes: $101.757 - $95 = $6.757 50
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If customers pay on day 30 and sales increase to $104, then the present value of these sales is: $103.503 1.06 $104 (30/365) = Profit becomes: ($103.503 - $ 95) = $8.503 In either case, granting credit increases profits. 4. The more stringent policy should be adopted because profit will increase. For every $100 of current sales: Current Policy More Stringent Policy Sales $100.0 $95.0 Less: Bad Debts* 6.0 3.8 Less: Cost of Goods** 80.0 76.0 Profit $14.0 $15.2 * 6% of sales under current policy; 4% under proposed policy ** 80% of sales 5. Consider the NPV (per $100 of sales) for selling to each of the four groups: Classification NPV per $100 Sales 1 2 3 4 If customers can be classified without cost, then Velcro should sell only to Groups 1, 2 and 3. The exception would be if non-defaulting Group 4 accounts subsequently became regular and reliable customers (i.e., members of Group 1, 2 or 3). In that case, extending credit to new Group 4 customers might be profitable, depending on the probability of repeat business.
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