Question

1. Cash discount (LO1) Compute the cost of not taking the following cash discounts. a. 2/10, net 40. b. 2/15, net 30. c. 2/10, net 45. d. 3/10, net 90.

2. Effective rate on discounted loan (LO2) Sol Pine borrows $5,000 for one year at 13 percent interest. What is the effective rate of interest if the loan is discounted?

3. Net credit position (LO1) McGriff Dog Food Company normally takes 27 days to pay for average daily credit purchases of $9,530. Its average daily sales are $10,680, and it collects accounts in 32 days. a. What is its net credit position? That is, compute its accounts receivable and accounts payable and subtract the latter from the former. b. If the firm extends its average payment period from 27 days to 37 days (and all else remains the same), what is the firm’s new net credit position? Has it improved its cash flow?

4. Effective rate under different terms (LO2) If you borrow $5,300 at $400 interest for one year, what is your effective interest rate for the following payment plans? a. Annual payment. b. Semiannual payments. c. Quarterly payments. d. Monthly payments.

5. Competing terms from banks (LO2) Summit Record Company is negotiating with two banks for a $151,000 loan. Fidelity Bank requires a 28 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 14 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10 percent. Compensating balances will be subtracted from the $151,000 in determining the available funds in part a. a. Calculate the effective interest rate for Fidelity Bank and Southwest Bank. Which loan should Summit accept? b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains $42,280 at each bank in deposits that will serve as compensating balances. c. Does your choice of banks change if the assumption in part b is correct?

Answer 1

1.

Explanations:

2/10, net 40 meaning = the due amount should be paid within 10 days to get 2% discount; otherwise the whole amount is due to be paid in 40 days.

2/15, net 30 meaning = the due amount should be paid within 15 days to get 2% discount; otherwise the whole amount is due to be paid in 30 days.

2/10, net 45 meaning = the due amount should be paid within 10 days to get 2% discount; otherwise the whole amount is due to be paid in 45 days.

3/10, net 90 meaning = the due amount should be paid within 10 days to get 3% discount; otherwise the whole amount is due to be paid in 90 days.

Required cost = (Discount rate / (100 – Discount rate)) × (360 days / (Payment days – discount days))

a.

Required cost = (2% / 98%) × (360 / (40 – 10))

                        = 2.04% × 12

                        = 24.48% (Answer)

b.

Required cost = (2% / 98%) × (360 / (30 – 15))

                        = 2.04% × 24

                        = 48.96% (Answer)

c.

Required cost = (2% / 98%) × (360 / (45 – 10))

                        = 2.04% × 10.29

                        = 20.99% (Answer)

d.

Required cost = (3% / 97%) × (360 / (90 – 10))

                        = 3.09% × 4.5

                        = 13.91% (Answer)