Académique Documents
Professionnel Documents
Culture Documents
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. 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:
(365 / 25)
100
−1 =0 .3431 = 34.31%
98
All sales are treated as if they were made at the end of the month;
therefore, the above calculation is correct for all sales.
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:
$101.92
= $101.757
1.06 (10/365)
Since costs remain unchanged at $95, profit becomes:
$101.757 – $95 = $6.757
1
If customers pay on day 30 and sales increase to $104, then the present value of
these sales is:
$104
= $103.503
1.06 (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 More Stringent
Policy 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
100 ×(1 − 0)
1 − 85 + = $13.29
1.15 45 / 365
2 100 × (1 −0 .02)
− 85 + = $11.44
1.15 42 / 365
100 × (1 −0 .10)
3 − 85 + = $ 3.63
1.15 40 / 365
2
6. By making a credit check, Velcro Saddles avoids a $7.41 loss per $100 sale
25 percent of the time. Thus, the expected benefit (loss avoided) from a credit
check is:
0.25 × $7.41 = $1.85 per $100 of sales, or 1.85%
A credit check is not justified if the value of the sale is less than x, where:
0.0185 x = $95
x = $5,135
7. Original terms:
$100
NPV per $100 sales = −$80 + = $17.70
1.12 75 / 365
Changed terms: Assume the average purchase is at mid-month and that the
months have 30 days.
0.60 × $98 0.40 × $100
NPV per $100 sales = − $ 80 + + = $17.27
1.12 30 / 365 1.12 80 / 365
8. For every $100 of prior sales, the firm now has sales of $102. Thus, the cost of
goods sold increases by 2%, as do sales, both cash discount and net:
NPV per $100 of initial sales = 1.02 × $17.27 = $17.62
10. a. Knob collects $180 million per year, or (assuming 360 days per year) $0.5
million per day. If the float is reduced by three days, then Knob gains by
increasing average balances by $1.5 million.
b. The line of credit can be reduced by $1.5 million, for savings per year of:
$1,500,000 × 0.12 = $180,000
c. The cost of the old system is $40,000 plus the opportunity cost of the extra
float required ($180,000), or $220,000 per year. The cost of the new
system is $100,000. Therefore, Knob will save $120,000 per year by
switching to the new system.
3
11. a. An increase in interest rates should decrease cash balances, because an
increased interest rate implies a higher opportunity cost of holding cash.
12. The cost of a wire transfer is $10, and the cash is available the same day.
The cost of a check is $0.80 plus the loss of interest for three days, or:
$0.80 + [0.12 × (3/365) × (amount transferred)]
Setting this equal to $10 and solving, we find the minimum amount transferred is
$9,328.
13. a. The lock-box will collect an average of ($300,000/30) = $10,000 per day.
The money will be available three days earlier so this will increase the
cash available to JAC by $30,000. Thus, JAC will be better off accepting
the compensating balance offer. The cost is $20,000, but the benefit is
$30,000.
b. Let x equal the average check size for break-even. Then, the number of
checks written per month is (300,000/x) and the monthly cost of the lock-
box is:
(300,000/x) (0.10)
The alternative is the compensating balance of $20,000. The monthly
cost is the lost interest, which is equal to:
(20,000) (0.06/12)
These costs are equal if x = $300. Thus, if the average check size is
greater than $300, paying per check is less costly; if the average check
size is less than $300, the compensating balance arrangement is less
costly.
4
14. Price of three-month Treasury bill = 100 – [(3/12) × 10] = 97.50
Yield = (100/97.50)4 – 1 = 0.1066 = 10.66%
Price of six-month Treasury bill = 100 – [(6/12) × 10] = 95.00
Yield = (100/95.00)2 – 1 = 0.1080 = 10.80%
Therefore, the six-month Treasury bill offers the higher yield.
17. Answers here will vary depending on when the problem is assigned.
18. Let X = the investor’s marginal tax rate. Then, the investor’s after-tax
return is the same for taxable and tax-exempt securities, so that:
0.0352 (1 – X) = 0.0244
Solving, we find that X = 0.3068 = 30.68%, so that the investor’s marginal tax
rate is 30.68%.
Numerous other factors might affect an investor’s choice between the two types
of securities, including the securities’ respective maturities, default risk, coupon
rates, and options (such as call options, put options, convertibility).
5
19. If the IRS did not prohibit such activity, then corporate borrowers would
borrow at an effective after-tax rate equal to [(1 – tax rate) × (rate on
corporate debt)], in order to invest in tax-exempt securities if this after-tax
borrowing rate is less than the yield on tax-exempts. This would provide
an opportunity for risk-free profits.
20. For the individual paying 35 percent tax on income, the expected after-tax
yields are:
a. On municipal note: 7.0%
b. On Treasury bill: 0.10 × (1 – 0.35) = 0.065 = 6.5%
c. On floating-rate preferred: 0.075 × (1 – 0.35) = 0.04875 = 4.875%
For a corporation paying 35 percent tax on income, the expected after-tax
yields are:
a. On municipal note: 7.0%
b. On Treasury bill: 0.10 × (1 – 0.35) = 0.065 = 6.50%
c. On floating-rate preferred (a corporate investor excludes from taxable
income 70% of dividends paid by another corporation):
Tax = 0.075 × (1 - 0.70) × 0.35 = 0.007875
After-tax return = 0.075 – 0.007875 = 0.067125 = 6.7125%
Two important factors to consider, other than the after tax yields, are the credit
risk of the issuer and the effect of interest rate changes on long-term securities.
6
Challenge Questions
7
2. a. For every $100 in current sales, Galenic has $5.0 profit, ignoring bad
debts. This implies the cost of goods sold is $95.0. If the bad debt ratio is
1%, then per $100 sales the bad debts will be $1 and actual profit will be
$4.0, a net profit margin of 4%.
c. There are many reasons why the predicted and actual default rates
may differ. For example, the credit scoring system is based on
historical data and does not allow for changing customer behavior.
Also, the estimation process ignores data from loan applications
that have been rejected, which may lead to biases in the credit
scoring system. If a company overestimates the accuracy of the
credit scoring system, it will reject too many applications.