ADMS 3530 Lecture Notes - Lecture 14: Financial Statement, Credit Analysis, Effective Interest Rate

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mag0sea

13 Feb 2017

School

York University

Department

Administrative Studies

Course

ADMS 3530

Professor

King Lois

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Document Summary

Net working capital, cash conversion cycle and operating cycle. Strike a balance between carrying costs and order costs (eoq model) Money market instruments can be used to invest idle cash. Whenever you sell goods you need to set the terms of sale. Companies offer credit, discount and payment terms on a sale. In many cases, payment is not made until after delivery, so the buyer receives credit. Example: a manufacturer requires payment within 30 days, but offers a 5% discount to customers who pay in 10 days. These terms would be called 5/10, net 30: A firm that buys on credit is in effect borrowing from its supplier. Trade credit is a form of short term financing. If you pass up a cash discount, the loan may be very expensive. You are offered terms of 3/15 net 45. The full value of the purchase is ,000.

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I just need part E the rest has been answered

Mississippi Delta, Inc. has been selling switching equipment to computer companies on net-30 terms, in which payment is expected by 30 days from the invoice date. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes: Prompt payors and laggards. Prompt payors (80 percent of Mississippi Deltaâs customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2 percent cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takes (who would then pay only 98% of the invoiced dollar amount) justifies the improved collection. The companyâs annual cost of capital is 11%. A.) Using NPV calculations, show the PV of the present collection experience. B.) Calculate the NPV of the proposed 2/10, net-30 terms. C.) Based on your NPV analysis, should Mississipi Delta Inc. adopt the cash discount? D.) What other factors should be taken into account before Mississippi Delta Inc. makes a switch, assuming such is justifiable on an NPV basis? E.) Sensivity analysis involves varying the key assumptions, one at a time, and observing the effect on the key decision criterion-such as profits or NPV. In the NPV analysis above, how could could one carry out sensitivity analysis? (If you have a financial spreadsheet available, conduct a sensitivity analysis that varies the number of prompt payors who will pay in exactly 10 days and report your findings.) *** Answer in an Excel document and give explanation as to how and why you got to your answer View comments (1) Expert Answer snarulatutor snarulatutor answered this 48 minutes later Was this answer helpful? 1 0 1,896 answers Since, there are multiple questions, the first four have been answered. ___________ Part A) To calculate the NPV, we need to determine the values of cash flows. Cash Flow on the 35th Day = Invoice Value*Customer Percentage Making the Payment on 35th Day = 4,000*80% = 3,200 Cash Flow on the 72th Day = Invoice Value*Customer Percentage Making the Payment on 72th Day = 4,000*20% = 800 The net present value of these 2 cash flows can be calculated as follows: Net Present Value = 3,200/(1+11%/365)^35 + 800/(1+11%/365)^72 = $3,949.26 ___________ Part B) To calculate the NPV, we need to determine the values of cash flows. Cash Flow on 10th Day = Invoice Value*Customer Percentage Taking Discount*(1-Discount Percentage) = 4,000*80%*50%*(1-2%) + 4,000*20%*20%*(1-2%) = $1,724.80 Cash Flow on 40th Day = Invoice Value*Customer Percentage Making Payment on 40th Day = 4,000*40% = $1,600 Cash Flow on 70th Day = Invoice Value*Customer Percentage Making Payment on 40th Day = 4,000*20%*80% = $640 The net present value of these 3 cash flows can be calculated as follows: Net Present Value = 1,724.80/(1+11%/365)^10 + 1,600/(1+11%/365)^40 + 640/(1+11%/365)^70 = $3,927.08 ___________ Part C) The net present value of cash flows with discount ($3,927.08) is less than the net present value of cash flows without discount ($3,949.26). Therefore, the company should not adopt the cash discount. ___________ Part D) Some of the other factors that should be taken into consideration include the possibility of default risk (as the credit period in case of laggards has increased to 80 resulting in higher probability of default). Another factor to be considered is the payment terms available from the suppliers. The company can adopt a cash discount policy, if it is also getting a discount on early payments to its suppliers. Credit policies used within the industry or by other companies of the same nature and size can be used as reference points while devising a credit policy.

I just need part E) and it explained

Page 1
1. (TCO 2) Select any actions that do not affect the cash account.Select all that apply: (Points : 3)
Goods are sold on credit
An interest payment on a notes payable is made
Raw materials are purchased and paid for with credit
A new machine is purchased and paid for with the business line ofcredit

2. (TCO 2) Which one of the following will increase the operatingcycle? (Points : 3)
increasing the accounts payable period
decreasing the accounts payable turnover rate
decreasing the cash cycle
increasing the accounts receivable turnover rate
increasing the inventory period

3. (TCO 2) Assume Green Leaf Nursery anticipated sales of $500 inthe first quarter. Accounts receivable at the beginning of the yearwas $300. Assuming a collection period of 30 days, which is theapproximate beginning balance for the second quarter? (Points :3)
$550
$630
$250
$170
None of the above

4. (TCO 2) Best Environment Engineering wrote a check and mailed itto the Electric Co. When the Electric Co. went to deposit thecheck, it discovered that the bank was closed due to flooding inthe area. It was 5 days before the Electric Co. could deposit thecheck from Best Environment Engineering. Because the Electric Co.'sbank was closed: (Points : 3)
Best Environment's collection float decreased.
the Electric Co.'s collection float decreased.
Best Environmentâs disbursement float increased.
the Electric Co.'s disbursements float increased.
the ledger balance of Best Environment was less than it would havebeen otherwise.

5. (TCO 2) Which of the following statements is true? Select allthat apply: (Points : 3)
The optimal credit policy minimizes the total cost of grantingcredit.

There is an opportunity cost associated with not offeringcredit.

An increase in a firm's average collection period generallyindicates that at least some customers are taking longer topay.

The costs of the credit application process and the costs expendedin the collection process are not carrying costs of grantingcredit.

Character refers to the ability of a firm to meet its creditobligations out its operating cash flows.

The optimal credit policy is the policy that produces the largestamount of sales for a firm.

6. (TCO 2) You place an order for 100 units of inventory Part A ata unit price of $522. The supplier offers terms of 1/25, net 40.How much should you remit if you take the discount? (Points :3)
$52,200
$39,150
$51,678
None of the above

7. (TCO 2) Auto Parts sells 1,200 electric parts per week and thenreorders another 1,200 parts. If the relevant carrying cost perelectric part is $4 and the fixed order cost is $750, what is thetotal carrying cost and the restocking cost, respectively? (Points: 3)
$2,400 and $39,900
$3,200 and $33,800
$2,400 and $39,000
$3,400 and $30,000
None of the above

8. (TCO 2) Company ABC has expected sales of 12,000 units thisyear, an ordering cost of $6 per order and carrying costs of $1.60per unit. What is the EOQ? (Points : 3)
310 units
300 units
150 units
155 units
None of the above

9. (TCO 2) The operating cycle begins when _____ and endswhen_____. (Points : 3)
inventory is purchased; inventory is sold
inventory is purchased; payment is received for the sale of thatinventory
inventory is purchased; the supplier of the inventory is paid
the sale of inventory occurs; payment is received for the sale ofthat inventory
the sale of inventory occurs; the supplier of the inventory ispaid

10. (TCO 2) List three examples of short-term investments. (Points: 3)

raspberrysquirrel337

INSTRUCTION: Answer all questions in this section. Each question carries 2 marks. Answer True or False to the following questions.

1. The cash conversion cycle of a firm is the length of time between the actual cash outflow for materials and the actual cash inflow from sales. To calculate this cycle, we need all the information used to calculate the operating cycle plus Days Payables Outstanding (DPO).

2. Net working capital is defined as current liabilities minus current assets.

3. Sales volume and collection period will be affected by a firm's credit policy.

4. Accounts payable, or trade credit, increases net working capital.

5. Efficient cash management is often concerned with speeding up the collection of cheques received and slowing down the payment of cheques issued.

Choose the letter a, b, c, or d that carries the best response.

6. The income statement reports the results of operations during the past year, the most important item being:

Net Income

Interest Expense

Earnings Before Interest and Taxes

Earnings Per Share

7. Which would represent claims against assets in the balance sheet:

Liabilities

Liabilities and stockholders' equity

Common stockholders' equity

Both common and preferred stockholders' equity

8. The two accounts that normally make up the common equity section of the balance sheet are and

accounts payable; accruals

common stock; retained earnings

long-term bonds; common stock

equity; liabilities

9. Accounting profits is different from net cash flow because

Net cash flow includes profits from operations.

Non-cash items are not included in the accounting profits

Net-cash flows take account of all non-cash items

Accounting profits overlooks depreciation and taxes

MGMT2023

Page 3

10. Which of the following represents an investing cash outflow?

An increase in holdings of stocks of other companies

A decrease in accounts payable

A decrease in gross property, plant and equipment

A decrease in accumulated depreciation

11. Which group of ratios show the combined effect of liquidity, asset management and debt on operating results?

Liquidity ratios

Debt ratios

Coverage ratios

Profitability ratios

12. Cottler Ltd. has current_. assets equal to $4.5 million. The company's current ratio is 1.25, and its quick ratio is 0.75. What is the firm's level of current liabilities in millions
	$3.6
	$0.18
	$2.4
	$2.9

13. You are given the following cash flows. What is the present value (t = 0) if the discount rate is 12 percent?

Time	0	1	2	3	4	5	6
Cash flows	0	1,000	2,000	2,000	2,000	0	-2,000

	PV= ?
	$3,277
	$4,169
	$5,302
	$4,289

14. You invest $5,000 today. You will earn 8% interest. How much will you have in 4 years? (Pick the closest answer.)

	$6,802
	$6,843
	$3,675
	$3,475

15. You are buying your first house for $220,000 and are paying $30,000 as a down payment. You have arranged a 30-year mortgage loan With a 7% nominal interest rate and monthly payments. What are the equal monthly payments you must make?

	$1,513
	$1,464
	$1,264
	$6,922

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ADMS 3530 Lecture Notes - Lecture 14: Financial Statement, Credit Analysis, Effective Interest Rate

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