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# Effective annual percentage rate of forgoing cash discount

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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.

#### 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

\$2.19
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