J under the current credit policy what is the firms

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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 change? 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 Credit-related costs: Carrying costs Bad debt losses Profit before taxes Taxes (40%) $ 250,000 8,000 20,000 $ 222,000 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, 41–57. ——, 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 1983, 40–44. Glasgo, Philip W., William J. Landes, and A. Frank Thompson, “Bank Discount, Coupon Equivalent, and Compound Yields,” Financial Management, Autumn 1982, 82–84. 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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