# Effective annual percentage rate of forgoing cash discount

7.

The Hopewell Pharmaceutical Company's balance sheet and income statement for last year are as follows:

Balance Sheet (in Millions of Dollars)

Assets Liabilities and Equity

Cash and marketable securities $1,100 Accounts payable $900

Accounts receivable 1,300 Accrued liabilities 300

Inventories* 800 Other current liabilities 700

Other current assets 200 Total current liabilities $1,900

Total current assets $3,400 Long term debt 1,000

Plant and equipment (net $2,300 Common stock 1,800

Other assets 1,000 Retained earnings 2,000

Total assets $6,700 Total stockholders'equity $3,800 Total liabilities and equity $6,700

*Assume the average inventory over the year was $800 million, that is, the same as ending inventory

Income Statement (in millions of dollars)

Net sales $6,500

Cost of sales 1,500

Selling, general, and administrative expenses 2,500

Other expenses 800

Total expenses $4,800

Earnings before taxes 1,700

Taxes 680

Earnings after taxes (net income) $1,020

a. Determine Hopewell's cash conversion cycle.

b. Give an interpretation of the value computed in (a)

4.

Calculate the effective annual percentage rate of forgoing the cash discount under each of the following credit terms:

a. 2/10, net 60

b. 2/10, net 60

7.

Pyramid Products Company has a revolving credit agreement with its bank. The company can borrow up to $1 million under the agreement at an annual interest rate of 9 percent. Pyramid is required to maintain a 10 percent compensating balance on any funds borrowed under the agreement and to pay a 0.5 percent commitment fee on the unused portion of the credit line. Assume that Pyramid has no funds in the account at the bank that can be used to meet the compensating balance requirement. Determine the annual financing cost of borrowing each of the following amounts under the credit agreement:

a. $250,000

b. $500,000

c. $1,000,000

8.

Walters Manufacturing Company has been approached by commercial paper dealer offering to sell an issue of commercial paper for the firm. The dealer indicates that Walters could sell a $5 million issue maturing in 182 days at an interest rate of 6 percent per annum (deducted in advance). The fee to the dealer for selling the issue would be $8,000. Determine Walters' annual financing cost of this commercial paper financing.

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#### Solution Preview

Inventory conversion period

Average Inventory/(Cost of Sales/365 )

= $800 / ($1,500/365) = 194.7 days

Receivables conversion period

Accounts Receivable/ (Annual Sales/365)

2.

Calculate the effective annual percentage rate of forgoing the cash discount under each of the following credit terms:

a. 2/10, net 60

b. 2/10, net 60

COST OF TRADE CREDIT TO THE CUSTOMER

R= C(365)/D(100-C)= 14.90%

C=CASH DISCOUNT= 2%

D= NO. OF EXTRA DAYS THAT CUSTOMER CAN USE SUPPLIERS'S FUNDS = 60-10= 50

R= ANNUAL INTEREST RATE FOR THE USE OF THESE FUNDS

b)2/10 net 30

COST OF TRADE CREDIT TO THE CUSTOMER

R= C(365)/D(100-C)= 37.24%

C=CASH DISCOUNT= 2%

D= NO. OF EXTRA DAYS THAT CUSTOMER CAN USE ...

#### Solution Summary

This provides the steps to calculate the effective annual percentage rate of forgoing the cash discount

What interest rate are you charging your "friend"? If you make your first deposit at the end of this year, and you would like your account to reach $20,000 when the final deposit is made, what will be the amount of your deposits? If the cost of common equity for the firm is 20 percent, the cost of preferred stock is 12 percent, and the before-tax cost of debt is 10 percent, what is Jower's cost of capital? What is the effective annualized cost of forgoing the discount? Calculate the project's NPV.

1. You lend a friend $15,000, for which your friend will repay you $37,313 at the end of five years. What interest rate are you charging your "friend"?

2. You plan to buy some property in Florida five years from today. To do this, you estimate that you will need $20,000 at that time for the purchase. You would like to accumulate these funds by making equal annual deposits in your savings account, which pays 12 percent annually. If you make your first deposit at the end of this year, and you would like your account to reach $20,000 when the final deposit is made, what will be the amount of your deposits?

3. The target capital structure for Jowers Manufacturing is 50 percent common stock, 15 percent preferred stock, and 35 percent debt. If the cost of common equity for the firm is 20 percent, the cost of preferred stock is 12 percent, and the before-tax cost of debt is 10 percent, what is Jower's cost of capital? The firm's marginal tax rate is 34 percent.

4. If a firm buys on trade credit terms of 2/10, net 60 and decides to forgo the trade credit discount and pay on the net day, what is the effective annualized cost of forgoing the discount?

5. Mo-Lee's Sportswear is considering building a new factory to produce soccer equipment. This project would require an initial cash outlay of $10,000,000 and will generate annual free cash inflows of $2,500,000 per year for eight years. Calculate the project's NPV given:

a. A required rate of return of 9 percent

b. A required rate of return of 11 percent

c. A required rate of return of 13 percent

d. A required rate of return of 15 percent