Managerial Finance Ch 28

Identify the real-world captive finance companies.

FMC GMAC

What does it imply if the buyer is presented with a draft and the buyer "accepts" it?

The buyer promises to pay it in the future.

What is the buyer's receivables period?

The time it takes the buyer to collect on the sale

Which of the following is true about bank acceptances?

They are actively traded in the money market. They are commonly used in international trade. A bank guarantees payment.

In practice, firms that grant credit often contract the credit function to:

a factor a captive finance company an insurance company

What type of account is created when a firm issues credit?

accounts receivable

The time period that it takes to collect on a credit sale is known as the _____.

accounts receivable period

The required return on receivables is a _____.

carrying cost of granting credit

A delay in payment can occur when a company extends _____.

credit

When a cash discount is offered, the credit is free ______ period.

during the discount

If a firm decides to grant credit to its customers, then it must _____.

establish procedures for extending credit and collecting

Low demand products may have a _____ credit period to try to increase sales.

longer

Credit analysis is important simply because _____.

of the potential losses on receivables

In order to entice buyers to pay early, a firm may _____.

offer a cash discount

With EOM dating, the seller bills ______ a month.

once

What fraction of all the assets of U.S. industrial firms are in the form of accounts receivable?

one-sixth

What is the length of time for which credit is granted called?

the credit period

The best predictor of whether or not someone will pay in the future is _____.

whether or not they've paid in the past

If the variable cost is $30 per unit, the price is $50, the probability of default is 16 percent, and the discount rate on receivables is 5 percent, then the NPV of granting credit to a one-time customer is _____.

$10 NPV = −$30 + (1 − 0.16) × $50/(1.05) = $10.

If the benefit of changing credit policies is expected to be $100 per month forever, and if the monthly required return is 1 percent, the present value equals _____.

$10,000 $100/0.01 = $10,000.

If granting credit results in an increase of sales of 20 items per month while the gross profit per unit remains constant at $30, then the present value of this perpetual change at a required return of 0.5 percent per month forever is _____.

$120,000 PV = (20 × $30)/0.005 =$120,000.

Suppose Veeco charges $150 per unit, its variable costs are $100 per unit, and it sells 1,000 units per month. The company is considering extending credit to its customers, allowing them 30 days to pay. Doing this is expected to increase sales to 120 units per month. What is the NPV of this proposal if its required rate of return is 3 percent?

$16,333 PV Benefit: [(120 − 100) × (150 − 100)]/0.03 = $33,333. PV Cost: [(120 − 100) × 100] + (150 × 100) = $17,000.

If the variable cost is $6, the probability of default is 50 percent, the price is $12, and the rate of return is 10 percent, the NPV of extending credit to a new customer who has the potential to be a repeat customer is _____.

$24 NPV = -$6 + (1 - 0.5)($12 - $6)/0.10 = $24.

If the variable cost is $20 per unit, the price is $40, the probability of default is 30 percent, and the discount rate on receivables is 3 percent, then the NPV of granting credit to a one-time customer is _____.

$7.18 NPV = −$20 + (1 − 0.3) × $40/(1.03) = $7.18.

If the credit terms are 1/10, net 30, then the buyer can pay $1,000 in 30 days or ______ in 10 days.

$990

If the cost of changing a credit policy is $5,000, and if the PV of the benefit is $4,500, then the NPV is _____.

-$500

If a company switches from all cash to net 30 sales, but there is no increase in sales (P × Q), then the NPV equals _____.

-PQ

If the credit terms are 1/10, net 30, then the buyer can pay full price in 30 days or take a ______ discount and pay in 10 days.

1 percent

The typical sequence of events that occur when a firm grants credit is _____.

1. the credit sale is made 2. the customer sends a check to the firm 3. the firm deposits the check 4. the firm's account is credited

About _____ of all assets of U.S. industrial firms are in the form of accounts receivable.

1/6

With 2/15, net 40 terms, a rational buyer either pays in ___ days or in ___ days. If he gives up the discount, he gets ___ days of free credit.

15; 40; 25

If the variable cost is $30, the price is $40, and the required return is 5 percent, then the break-even probability of default for a one-time customer is _____.

21 percent π = 1 - $30/$40 × 1.05 = 21%.

Suppose a firm currently offers terms of net 40 and has an average collection period (ACP) of 40 days. If it offers terms of 1/10, net 40, and if 40 percent of the customers pay in 10 days and 60 percent pay in 40 days, then the new ACP will be ______ days.

28 ACP = 0.60 × 40 + 0.40 × 10 = 28 days.

If the terms of sales are 3/15, net 60, what is the discount available?

3 percent if paid within 15 days

What is the break-even sales increase a company needs if its current sales level is $5,400, its price and variable cost per unit are $30 and $20, respectively, and the discount rate is 5 percent per period?

30 units $5,400/(10/0.05 - 20) = 30 units.

If the variable cost is $20, the price is $50, and the required return is 25 percent, then the break-even probability of default for a one-time customer is _____.

50 percent π = 1 - $20/$50 × 1.25 = 50%.

What is the effective annual cost of forgoing a discount if terms are 2/15, net 30?

63.49 percent (1.020408)365/15 − 1 = 0.6349, or 63.49%.

Which of the following are true?

Credit insurance offers coverage up to a preset dollar limit. Firms with internal credit operations are self-insured against default.

Which of the following are the most popular business credit reporting agencies?

Experian Dun & Bradstreet

True or false: The standard credit period is normally between 6 to 12 months.

False

True or false: Credit analysis refers to the process of deciding whether or not to extend credit to customers in general. True false question.

False It refers to a particular customer, not customers in general.

True or false: A seller cannot offer different terms to different buyers.

False The terms can vary. For example, a wholesaler is likely to get better terms than a retailer.

True or false: There is no downside to extending trade credit.

False There are two costs to extending trade credit: 1) there is a chance the customer will not pay, and 2) the firm has to bear the costs of carrying the receivables.

Some examples of real-world captive finance companies are _____.

Ford Motor Credit GMAC

What is the another term for a promissory note?

IOU

What is the danger of extending credit?

It may lead to delays in payment.

Which of the following statements are true about extending credit?

Repeat business is a crucial consideration. Extending credit to everyone is not a bad strategy.

What trade-offs are made when trade credit is issued?

Sales may increase but the cost of carrying receivables will also increase. Sales may increase but the probability of defaults will also increase.

____ dating might be used to encourage sales of products during off-season.

Seasonal

True or false: Banker's acceptances are common in international trade.

True

True or false: In analyzing repeat customers, it is often assumed that a customer who does not default the first time will never default.

True

True or false: Sellers frequently quote different credit terms to wholesale and retail customers.

True

True or false: A credit instrument is the basic evidence of indebtedness.

True It is signed and recorded by both parties.

Whether the firm sells for cash or credit, it will still have to _____.

acquire or produce the merchandise and pay for it

The main problem with promissory notes is that they are signed _____.

after the delivery of goods

Where do credit sales appear in the balance sheet?

as accounts receivable under current assets

The credit period generally increases _____.

as the size of an account increases

When a draft is signed and stamped by the bank it is called a _____ _____.

bankers acceptance

A commercial draft is a way to obtain a credit commitment from a customer ______ the goods are delivered.

before

The invoice date represents the _____.

beginning of the credit period

Two major factors that affect the length of the credit period are the _____.

buyer's inventory period operating cycle

The amount of time it takes the buyer to collect on a sale is known as the _____.

buyer's receivables period

The time it takes the buyer to acquire inventory, process it, and sell it is known as the _____.

buyers inventory period

How can the receivables period be reduced?

by reducing processing float by speeding up check mailing

A(n) ______ finance company is a wholly owned subsidiary that handles the credit function for the parent company.

captive

Extending more than the cost-minimizing amount of credit will not cover the ______ costs of the investment in receivables.

carrying

Total credit cost is minimized when _____.

carrying costs equal opportunity costs

Which of the following refers to an asset pledged in the case of default?

collateral

The three components of credit policy are _____.

collection policy credit analysis terms of the sale.

What are the main components of a credit policy?

collection policy terms of sale credit analysis

With a conditional sales contract, the selling firm will retain legal ownership of the goods until the customer _____.

completes the payment

Which of the following factors are used in evaluating credit policy?

cost effects revenue effects the cost of debt

Some problems with issuing credit are _____.

cost of carrying receivables the risk of the customer not paying

For which of the following types of sales would the firm be most likely to suffer nonpayment?

credit

The procedures businesses go through to determine if a customer is likely to pay is called _____.

credit analysis

What is the process of deciding whether or not to extend credit to a particular customer called?

credit analysis

The factor may have full responsibility for which of the following?

credit checking authorization

The sum of the carrying costs and the opportunity costs of a particular credit policy is called the _____.

credit cost curve

The terms of sale specify the:

credit period discount period cash discount type of credit instrument

Issuing credit is an investment in the _____.

customer

The optimal amount of credit is determined when the incremental cash flows from increased sales are _______ the incremental costs of carrying the increase in investment in accounts receivable.

exactly equal to

All things equal, which firm characteristic will NOT usually lead to a firm granting more credit?

fewer repeat customers

The cost of debt matters in evaluating credit policy because the resulting receivables must be ______.

financed

Which of the following are sources of information for assessing creditworthiness?

financial statements banks

Firms can sometimes achieve a lower overall cost of debt by _____.

forming a separate company to handle the credit function

Which of the following are steps in the credit-granting process?

gathering relevant information determining creditworthiness

The role of the cash discount in credit policy is to _____.

get customers to pay early

Because of cash discounts, businesses that extend credit are able to charge ______ prices to customers that use credit.

higher

Conditional sales contracts are usually paid _____.

in installments

A firm that grants credit may experience an increase in revenue due to an increase in price and a(n) ______ in quantity sold.

increase

Issuing credit to customers should _____.

increase sales

The major reason for issuing credit is to _____.

increase sales

The optimal amount of credit is determined when the ______ cash flows from increased sales are exactly equal to the incremental costs of carrying the increase in investment in accounts receivable.

incremental

Granting credit results in delayed revenues, but the costs of sales is _____.

incurred immediately

The two components of the operating cycle are called the ______ period and the ______ period.

inventory; receivables

A(n) _____ is a written account of merchandise shipped to the buyer.

invoice

Because most trade credit is offered on open account, the most used credit instrument is the _____.

invoice

Issuing credit creates a trade-off between increased sales and the cost of _____.

issuing credit

Sellers may offer even ______ credit periods for off-season sales.

longer

With higher levels of competition, a _____ credit period is a good way of attracting customers.

longer

Which of the following are opportunity costs of refusing to grant credit?

losing the ability to charge a higher price a decrease in quantity sold

Perishable items usually have a relatively _____ collateral value.

low

All things equal, which firm characteristics will usually lead to a firm granting more credit?

low variable operating costs the presence of excess capacity

Which of the following are part of collection policy procedures?

monitoring receivables collecting on past-due amounts

The appropriate upper limit to the credit period is the length of the buyer's ______.

operating cycle

When the seller's credit period exceeds the buyer's inventory period, then the seller is financing _____.

part of the buyer's receivables the buyer's inventory purchases

In granting credit, a firm must assume some _____.

probability of nonpayment

A(n) _____ note is essentially an IOU that a customer will sign when an order is large.

promissory

Issuing credit to customers will:

promote sales make an investment in a customer

Cash discounts encourage early payment which reduces the firm's investment in _____.

receivables

If our credit period exceeds the buyer's inventory period, then we are financing not only the buyer's inventory purchases but also part of the buyer's ______.

receivables

The focus of credit analysis is on losses incurred on _____.

receivables

If a firm grants credit, then there will be a delay in _____.

revenue collections

Which of the five basic factors in evaluating credit policy is impacted by possible price and quantity effects?

revenue effects

Firms that manage internal credit operations are _______ against default.

self-insured

The decision to forgo a trade discount almost surely works to the __________ advantage.

sellers

Factoring is an arrangement where a firm ______ its receivables.

sells

The primary reason to set up a credit function subsidiary is to ______ the production and financing of the firm's products for management, financing, and reporting.

separate

The cost of ______ borrowing is a factor in the decision to grant credit.

short-term

A higher credit risk buyer will usually receive a _____ credit period.

shorter

A lower priced item will tend to have a _____ credit period.

shorter

If there is very little competition, the credit period offered is likely to be _____.

shorter

Perishable items usually have a ____ credit period.

shorter

Relatively standardized goods and raw materials tend to have ______ credit periods.

shorter

The smaller the account, the ______ the credit period.

shorter

There are two buyers, Sam and Bradley. Sam has a higher credit risk than Bradley. We can conclude that the credit period for Sam will be relatively _____.

shorter than Bradley's credit period

Immediate payment is required on a _____ draft.

sight

Which of the following are not ways to reduce the receivables period?

slow down check processing slow down check clearing

A company will offer a discount in order to _____.

speed up the collection of receivables

With terms of 2/10, net 30, and an order of $1,000, the cost of not taking the discount is computed assuming that _____.

the buyer borrows for 20 days the buyer pays $20 in interest on the "loan" the buyer borrows $980

The credit period will be shorter when _____.

the buyer's inventory period is shorter the buyer's operating cycle is shorter

What are the two components of the credit period when a cash discount is offered?

the cash discount period the net credit period

What does a credit score show?

the creditworthiness of a customer

The change in quantity sold under a new credit policy is _____.

the extra potential profit from credit sales that are lost because credit is refused

If the level of receivables is below the minimum total credit costs, then _____.

the firm is forgoing valuable profit opportunities

What provides a written documentation of merchandise shipped to a buyer?

the invoice

What is the beginning of the credit period called?

the invoice date

Which of the following are forms of carrying costs when granting credit?

the losses from bad debts the required return on receivables

If a firm decides not to extend credit to a returning customer, it will collect _____.

the price

The net credit period is _____.

the time by which the customer has to pay

The credit period refers to _____.

the time for which credit is granted

What is the inventory period?

the time from acquisition of inventory to sale of inventory

The term 2/10, net 60 means _____.

there is a 2 percent discount if the invoice is paid off in 10 days, otherwise the entire amount is due in 60 days

If immediate payment is not required on a draft, then it is a ______ draft.

time

The cash discount period is the _____.

time during which the discount is available

Why do firms perform credit analysis?

to determine the creditworthiness of customers

If credit is extended to a returning customer, the ______ sales price is risked.

total

Cash discounts allow businesses to charge higher prices to customers that _____.

use the credit extended to them