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Unformatted text preview: SO be if the credit policy change were made?
k. What is the dollar amount of the firm’s current bad debt losses? What losses would be expected
under the new policy?
l. What would be the firm’s expected dollar cost of granting discounts under the new policy?
m. What is the firm’s current dollar cost of carrying receivables? What would it be after the proposed
n. What is the incremental after-tax profit associated with the change in credit terms? Should the company make the change? (Assume a tax rate of 40 percent.)
o. Suppose the firm makes the change, but its competitors react by making similar changes to their
own credit terms, with the net result being that gross sales remain at the current $1,000,000 level.
What would the impact be on the firm’s post-tax profitability? Selected Additional References and Cases New Old Gross sales
Less discounts $1,000,000
750,000 Profit before credit costs and taxes
Bad debt losses
Profit before taxes
Taxes (40%) $ 250,000
88,800 Net income Difference $1,000,000
0 Net sales
Production costs 27-31 $ 133,200 p. The brothers are considering taking out a 1-year bank loan for $100,000 to finance part of their
working capital needs and have been quoted a rate of 8 percent. What is the effective annual cost
rate assuming (1) simple interest, (2) discount interest, (3) discount interest with a 10 percent compensating balance, and (4) add-on interest on a 12-month installment loan? For the first 3 of these
assumptions, would it matter if the loan were for 90 days, but renewable, rather than for a year?
q. How large would the loan actually be in each of the cases in part p? Selected Additional References and Cases
The following articles provide more information on short-term financial management:
Gentry, James A., “State of the Art of
Short-Run Financial Management,”
Financial Management, Summer 1988,
——, and Jesus M. De La Garza, “Monitoring Accounts Payables,” Financial
Review, November 1990, 559–576.
Articles that address credit policy and receivables management include the following:
Gallinger, George W., and A. James Ifflander, “Monitoring Accounts Receivable
Using Variance Analysis,” Financial
Management, Winter 1986, 69–76.
Gentry, James A., and Jesus M. De La
Garza, “A Generalized Model for Monitoring Accounts Receivable,” Financial
Management, Winter 1985, 28–38.
Mian, Shehzad L., and Clifford W. Smith,
“Extending Trade Credit and Financing
Receivables,” Journal of Applied Corporate Finance, Spring 1994, 75–84.
Sachdeva, Kanwal S., and Lawrence J. Gitman, “Accounts Receivable Decisions in
a Capital Budgeting Framework,” Financial Management, Winter 1981, 45–49. Weston, J. Fred, and Pham D. Tuan,
“Comment on Analysis of Credit Policy
Changes,” Financial Management,
Winter 1980, 59–63.
For a discussion of effective yields, see
Finnerty, John D., “Bank Discount, Coupon
Equivalent, and Compound Yields: Comment,” Financial Management, Summer
Glasgo, Philip W., William J. Landes, and
A. Frank Thompson, “Bank Discount,
Coupon Equivalent, and Compound
Yields,” Financial Management, Autumn
The following cases from the Finance
Online Case Library cover many of the
concepts discussed in this chapter and are
available at http://www.textchoice.com:
Case 33, “Upscale Toddlers, Inc.,” which
deals with credit policy changes.
Case 34, “Texas Rose Company,” which
focuses on receivables management.
Case 62, “Western Supply Company,”
which illustrates the effects of a change
in credit policy on corporate profitability
and cash flow....
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