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Answers and Solutions: 27 - 11
Face amount of loan =
65.0
67.416$
20.015.01
67.416$
= $641.03.
Doesn’t Take Discounts:
If Malone doesn’t take discounts, its A/P balance would be $250. The cash needed
from the bank is $500 - $250 = $250.
Face amount of loan =
65.0
250$
20.015.01
250$
= $384.62.
c. Nonfree Trade Credit:
Answers and Solutions: 27 - 13
Total current Total current
assets $1,384.6 liabilities $ 734.6
Fixed assets 750.0 Long-term debt 150.0
Common equity 1,250.0
Total assets $2,134.6 Total claims $2,134.6
Answers and Solutions: 27 - 14
e. To reduce the accounts payable by $250,000, which reflects the 1% discount, Malone
payable is the gross amount minus the tax shield: $252,525.25 - $1,010.10 =
$251,515.15.
Face amount of loan =
0.65
5$251,515.1
0.200.151
5$251,515.1
= $386,946.38.
Pro Forma Balance Sheet (Thousands of Dollars):
Casha $ 127.4 Accounts payable $ 250.0
Accounts receivable 450.0 Notes payableb 436.9
Inventory 750.0 Accruals 50.0
Prepaid interest 58.0
a $386,946.38(0.2) = $77,389.27 = Compensating balance.
Cash = $50 + $77.4 = $127.4.
b Notes payable = $50 + $386.9 = $436.9.
c Common equity = Previous common equity – after-tax lost discount
= $1,250 - $1.5 = $1,248.5
27-10 a. 1. Line of credit:
Commitment fee = (0.005)($2,000,000)(11/12) = $ 9,167
Interest = (0.11)(1/12)($2,000,000) = 18,333
Total $27,500
2. Trade discount:
Nominal
2
360
Answers and Solutions: 27 - 16
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
b. The lowest cost of financing is not necessarily the best. The use of 30-day
commercial paper is the cheapest; however, sometimes the commercial paper market
is tight and funds are not available. This market also is impersonal. A banking
arrangement may provide financial counseling and a long-run relationship in which
the bank performs almost as a "partner and counselor" to the firm. Note also that
while the use of 60-day commercial paper is more expensive than the use of 30-day
paper, it provides more flexibility in the event the money is needed for more than 30
days. However, the line of credit provides even more flexibility than the 60-day
commercial paper and at a lower cost.
website, in whole or in part.
SOLUTION TO SPREADSHEET PROBLEM
27-11 The detailed solution for the spreadsheet problem, Ch27 P11 Build a Model
Solution.xlsx, is available on the textbook’s Web site.
Mini Case: 27- 18
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
MINI CASE
Rich Jackson, a recent finance graduate, is planning to go into the wholesale building
supply business with his brother, Jim, who majored in building construction. The firm
would sell primarily to general contractors, and it would start operating next January.
Sales would be slow during the cold months, rise during the spring, and then fall off again
in the summer, when new construction in the area slows. Sales estimates for the first 6
months are as follows (in thousands of dollars):
Jan $100
Feb 200
Mar 300
Apr 300
May 200
Jun 100
The terms of sale are net 30, but because of special incentives, the brothers expect 30
percent of the customers (by dollar value) to pay on the 10th day following the sale, 50
percent to pay on the 40th day, and the remaining 20 percent to pay on the 70th day. No
bad debt losses are expected, because Jim, the building construction expert, knows which
contractors are having financial problems.
a. Discuss, in general, what it means for the brothers to set a credit and collections
policy.
Answer: When a firm sets its credit and collections policy it determines four things:
require the investment of funds, so a firm must take both the profits from additional
sales and the additional capital required to fund accounts receivable when it
determines a credit policy.
Mini Case: 27 - 19
website, in whole or in part.
b. Assume that, on average, the brothers expect annual sales of 18,000 items at an
average price of $100 per item. (use a 365-day year.)
1. What is the firm’s expected days sales outstanding (DSO)?
b. 2. What is its expected average daily sales (ADS)?
365
)100($000,18
b. 3. What is its expected average accounts receivable (AR) level?
b. 4. Assume that the firm’s profit margin is 25 percent. How much of the 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 one
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.
this if notes payable are used to finance receivables:
Accounts receivable $182,466 Notes payable $136,849
Retained earnings 45,616
$182,466
Mini Case: 27- 20
website, in whole or in part.
b. 5. If bank loans have a cost of 12 percent, what is the annual dollar cost of carrying
the receivables?
state of the economy and competition within the industry affect average daily
sales, but so does the firm's credit policy. The days sales outstanding depends
mainly on credit policy, although poor economic conditions can lead to a
reduction in customers' ability to make payments.
2. For a given level of receivables, the lower the profit margin, the higher the cost of
carrying receivables, because the greater the portion of each sales dollar that must
actually be financed. Similarly, the higher the cost of the financing, the higher the
dollar cost of carrying the receivables.
