BA303 - Tutorial 10

BA 303 CORPORATE FINANCE
TUTORIAL ASSET MANAGEMENT

1. The average collection period measures the:
a. number of days between when a typical credit sale is made and when the firm receives the
payment
b. number of days it takes a typical check to "clear" through the banking system
c. number of days beyond the end of the credit period before a typical customer payment is
received
d. number of days before a typical account becomes delinquent
2. Relaxing (i.e., lowering) the firm's credit standards is likely to result in
a. lower sales
b. smaller bad-debt losses
c. a shorter average collection period
d. possible higher pre-tax profits
3. The primary objective of offering a cash discount is to
a. reduce the firm's level of receivables investment
b. reduce the number of bad checks received from customers
c. encourage customers to place their orders prior to the peak selling period
d. avoid just-in-time orders
4. Character, which is one of the traditional "five Cs" of credit analysis, refers to
a. the ability of the applicant to meet its financial obligations (i.e., liquidity and cash flow)
b. the general economic climate and its effect on the applicant's ability to pay
c. the financial strength of the applicant (i.e., net worth)
d. the willingness of the applicant to meet its financial obligations
5. ____ are the criteria the firm uses to screen credit applicants in order to determine which of its customers
should be offered credit and how much.
a. Credit terms
b. Credit standards
c. Seasonal datings
d. Credit extension policies
6. All the following are assumptions of the basic EOQ model except:
a. annual demand known with certainty
b. ordering costs fluctuate
c. demand is uniform throughout the year
d. orders are filled instantaneously
7. Mace Auto Parts Company sells to retail auto supply stores on credit terms of "net 60". Annual credit
sales are $300 million (spread evenly throughout the year) and its accounts average 28 days overdue.
The firm's variable cost ratio is 0.75 (i.e., variable costs are 75 percent of sales). When converting from
annual to daily data or vice versa, assume there are 365 days per year. Determine Mace's average
collection period.
a. 88 days
b. 44 days
c. 74 days
d. 60 days
a. Determine Mace's average investment in receivables.
BA 303 CORPORATE FINANCE

TUTORIAL ASSET MANAGEMENT
b. Suppose that Mace's sales are expected to increase by 20 percent next year and, through more
effective collection methods, the firm is able to reduce its average collection period by 20 days.
Determine the firm's average investment in receivables for next year under these conditions.
8. Warren Motor Company sells $30 million of its products to wholesalers on terms of "net 30." Currently,
the firm's average collection period is 48 days. In an effort to speed up the collection of receivables,
Warren is considering offering a cash discount of 2 percent if customers pay their bills within 10 days.
The firm expects 50 percent of it's customers to take the discount and it's average collection period to
decline to 30 days. The firm's required pretax return (i.e. opportunity cost) on receivables investment is
16 percent. Determine the cost of the cash discounts to Warren.
a. Determine Warren's pretax earnings on the funds released from the reduction in receivables. (Assume a
365 day year)
b. Determine the net effect on Warren's pretax profits of offering a 2 percent cash discount.
9. Willoughby Industries, Inc. is considering whether to discontinue offering credit to customers who are
more than 10 days overdue on repaying the credit extended to them. Current annual credit sales are $10
million on credit terms of "net 30". Such a change in policy is expected to reduce sales by 10 percent, cut
the firm's bad-debt losses from 5 to 3 percent, and reduce its average collection period from 72 days to
45 days. The firm's variable cost ratio is 0.70 (profit contribution ratio is 0.30) and its required pretax
return (i.e. opportunity cost) on receivables investments is 25 percent. Determine the net effect of this
credit tightening policy on the pretax profits of Willoughby. When converting from annual to daily data
or vice versa, assume that there are 365 days per year.
10. If a lawn mower assembly plant orders 25,000 frames per year at a price of $27 each, what is the EOQ if
the ordering cost per order is $35 and the annual inventory carrying cost is 12 percent?
11.Tool Mart sells 1400 electronic water pumps every year. These pumps cost $54.30 each. If annual
inventory carrying costs are 12% and the cost of placing an order is $90, what is the optimal ordering
frequency?
What is the total annual inventory costs?
12.
13.What information could be used to judge the credit worthiness of a customer?

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BA 303 CORPORATE FINANCE

TUTORIAL ASSET MANAGEMENT

BA 303 CORPORATE FINANCE

13.What information could be used to judge the credit worthiness of a customer?

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