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FM II Assignment 17 W22

This document contains 5 practice problems related to working capital management. The first problem asks about calculating days sales outstanding (DSO), the second asks about trade credit costs, the third asks about nominal and effective interest rates on trade credit, the fourth asks about calculating monthly loan payments on an add-on loan, and the fifth asks about calculating return on equity given changes in interest rates on short and long-term debt.

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90 views

FM II Assignment 17 W22

This document contains 5 practice problems related to working capital management. The first problem asks about calculating days sales outstanding (DSO), the second asks about trade credit costs, the third asks about nominal and effective interest rates on trade credit, the fourth asks about calculating monthly loan payments on an add-on loan, and the fifth asks about calculating return on equity given changes in interest rates on short and long-term debt.

Uploaded by

Farah Imami
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Lahore School of Economics

Financial Management II
Working Capital Management – 4
Chapter 16 Assignment 17

Examples
1. Lamar Lumber Company has sales of $10 million per year, all on credit terms calling for payment within 30 days; and
its accounts receivable are $2 million. What is Lamar’s DSO, what would it be if all customers paid on time, and how much
capital would be released if Lamar could take action that led to on-time payments?

2. Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 60; and it currently pays after 5 days
and takes discounts. Lamar plans to expand, which will require additional financing. If Lamar decides to forgo discounts,
how much additional credit could it get and what would be the nominal and effective cost of that credit? If the company
could get the funds from a bank at a rate of 10%, interest paid monthly, based on a 365-day year, what would be the
effective cost of the bank loan? Should Lamar use bank debt or additional trade credit? Explain.

Problems for Assignment


1. Diana’s Designs just recently opened as an upscale dress shop in northeast Florida. The owner is trying to decide
whether to take the discount offered from her suppliers, or whether to pay at the end of the month. Diana’s suppliers are
offering her a 3% discount if she pays within 15 days; otherwise, the balance is due 30 days after purchase. What are
Diana’s nominal and effective annual costs of trade credit?

2. McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500; 40% of the customers pay on
the 10th day and take discounts, while the other 60% pay, on average, 40 days after their purchases.
a) What is the days’ sales outstanding?
b) What is the average amount of receivables?
c) What is the percentage cost of trade credit to customers who take the discount?
d) What is the percentage cost of trade credit to customers who do not take the discount and pay in 40 days?
e) What would happen to McDowell’s accounts receivable if it toughened up on its collection policy with the result that
all non-discount customers paid on the 30th day?

3. If a firm borrowed $500,000 at a rate of 10% simple interest with monthly interest payments and a 365-day year, what
would be the required interest payment for a 30-day month? If interest must be paid monthly, what would be the effective
annual rate?

4. If the above loan had been made on a 10% add-on basis payable in 12 end-of-month installments, what would be the
monthly payments? What is the annual percentage rate? The effective annual rate?

5. Vanderheiden Press Inc. and Herrenhouse Publishing Company had the following balance sheets as of December 31,
2018 (thousands of dollars):
Earnings before interest and taxes for both firms are $30 million, and the effective federal plus-state tax rate is 40%.
a) What is the return on equity for each firm if the interest rate on short-term debt is 10% and the rate on long-term
debt is 13%?
b) Assume that the short-term rate rises to 20%. Although the rate on new long-term debt rises to 16%, the rate on
existing long-term debt remains unchanged. What would be the returns on equity for Vanderheiden Press and
Herrenhouse Publishing under these conditions?
c) Which company is in a riskier position? Why?

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