Mini case 27 29 4 assume that the firms profit margin

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Unformatted text preview: e receivables balance must be financed? What would the firm’s balance sheet figures for accounts receivable, notes payable, and retained earnings be at the end of 1 year if notes payable are used to finance the investment in receivables? Assume that the cost of carrying receivables had been deducted when the 25 percent profit margin was calculated. (5) If bank loans have a cost of 12 percent, what is the annual dollar cost of carrying the receivables? c. What are some factors that influence (1) a firm’s receivables level and (2) the dollar cost of carrying receivables? d. Assuming that the monthly sales forecasts given previously are accurate, and that customers pay exactly as was predicted, what would the receivables level be at the end of each month? To reduce calculations, assume that 30 percent of the firm’s customers pay in the month of sale, 50 percent pay in the month following the sale, and the remaining 20 percent pay in the second month following the sale. Note that this is a different assumption than was made earlier. Also assume there are 91 days in each quarter. Use the following format to answer parts d and e: QUARTERLY Month Sales End-of-Month Receivables January $100 $ 70 February 200 160 March 300 250 April 300 May 200 June Sales Ads $600 DSO $6.67 (A/R)(ADS) 100 37.5 e. What is the firm’s forecasted average daily sales for the first 3 months? For the entire half-year? The days sales outstanding is commonly used to measure receivables performance. What DSO is expected at the end of March? At the end of June? What does the DSO indicate about customers’ payments? Is DSO a good management tool in this situation? If not, why not? f. Construct aging schedules for the end of March and the end of June (use the format given below). Do these schedules properly measure customers’ payment patterns? If not, why not? MARCH Age of Account (Days) JUNE A/R % 84% 0–30 $210 31–60 40 0 % 16 61–90 A/R 0 $250 100% g. Construct the uncollected balances schedules for the end of March and the end of June. Use the format given below. Do these schedules properly measure customers’ payment patterns? MARCH Contribution to A/R JUNE A/R-toSales Ratio Month Sales January $100 February 200 40 20 May March 300 210 70 June $ 0 0% Month April Sales Contribution to A/R A/R-toSales Ratio 27-30 Chapter 27 Providing and Obtaining Credit h. Assume that it is now July of Year 1, and the brothers are developing pro forma financial statements for the following year. Further, assume that sales and collections in the first half-year matched the predicted levels. Using the Year 2 sales forecasts as shown next, what are next year’s pro forma receivables levels for the end of March and for the end of June? Month January February March Predicted Sales $150 300 500 Predicted A/R-toSales Ratio Predicted Contribution to Receivables 0% 20 70 Projected March 31 A/R balance April May June $0 60 350 $410 $400 300 200 Projected June 30 A/R balance i. Assume now that it is several years later. The brothers are concerned about the firm’s current credit terms, which are now net 30, which means that contractors buying building products from the firm are not offered a discount, and they are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80 percent (by dollar volume) of the firm’s paying customers generally pay the full amount on Day 30, while the other 20 percent pay, on average, on Day 40. Two percent of the firm’s gross sales end up as bad debt losses. The brothers are now considering a change in the firm’s credit policy. The change would entail (1) changing the credit terms to 2/10, net 20, (2) employing stricter credit standards before granting credit, and (3) enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2 percent discount, but all others would have to pay the full amount after only 20 days. The brothers believe that the discount would both attract additional customers and encourage some existing customers to purchase more from the firm—after all, the discount amounts to a price reduction. Of course, these customers would take the discount and, hence, would pay in only 10 days. The net expected result is for sales to increase to $1,100,000; for 60 percent of the paying customers to take the discount and pay on the 10th day; for 30 percent to pay the full amount on Day 20; for 10 percent to pay late on Day 30; and for bad debt losses to fall from 2 percent to 1 percent of gross sales. The firm’s operating cost ratio will remain unchanged at 75 percent, and its cost of carrying receivables will remain unchanged at 12 percent. To begin the analysis, describe the four variables that make up a firm’s credit policy, and explain how each of them affects sales and collections. Then use the information given in part h to answer parts i through q. j. Under the current credit policy, what is the firm’s days sales outstanding (DSO)? What would the expected D...
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