Working Capital Exercises – Part 2 1. Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to 11,000 units during the coming year; the average collection period is expected to increase from 45 to 60 days; and bad debts are expected to increase from 1% to 3% of sales. The sales price and variable cost per unit are P40 andP11, respectively. The firm’s required rate of return is 25%.
Should the change in credit standards be undertaken? 2. Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The firm’s current average collection period is 60 days, sales are 40,000 units, selling price is P45 per unit, and variable cost per unit is P36. The firm expects that the change in credit terms will result in an increase in sales to 42,000 units, that 70% of the sales will take the discount, and that the average collection period will fall to 30 days.
If the firm’s hurdle rate is 25%, should the proposed discount be offered? 3. Parker Tool is considering lengthening its credit period from 30 to 60 days. All customers will continue to pay on the net date. The firm currently bills P450,000 for sales and has P345,000 in variable costs. The change in credit terms is expected to increase sales to P510,000. Bad debt expenses will increase from 1% to 1. 5% of sales. The firm has a required rate of return of 20%.
Should the change in credit terms be undertaken? 4. 5. The credit terms for each of three suppliers are shown in the following table. Supplier| Credit terms| X| 1/10 net 55 EOM| Y| 2/10 net 30 EOM| Z| 2/20 net 60 EOM| a. Determine the approximate cost of giving up the cash discount from each supplier. b. Assuming that the firm needs short-term financing, indicate whether it would be better to give up the cash discount or take the discount and borrow from a bank at 15% annual interest.
Evaluate each supplier separately in part a. c. What impact, if any, would the fact that the firm could stretch its accounts payable (net period only) by 20 days from Supplier Z have on your answer in part b relative to this supplier? 6. Compute the cost of a P100,000 90-day bank loan at an annual interest rate of 15%, payable at maturity. What is the cost if the loan is discounted – i. e. , interest is deducted in advance?