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Finance Problems: Credit, Zero-Balance Account, and Annual Rate

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1. Relaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to 11,000 units during the coming year; the average collection period is expected to increase from 45 to 60 days; and bad debts are expected to increase from 1% to 3% of sales. The sale price per unit is $40, and the variable cost per unit is $31. The firm's required return on equal-risk investments is 25%. Evaluate the proposed relaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)

2. Zero-balance account Union Company is considering establishment of a zero balance account. The firm currently maintains an average balance of $420,000 in its disbursement account. As compensation to the bank for maintaining the zero-balance account, the firm will have to pay a monthly fee of $1,000 and maintain a $300,000 non-interest-earning deposit in the bank. The firm currently has no other deposits in the bank. Evaluate the proposed zero-balance account, and make a recommendation to the firm, assuming that it has a 12% opportunity cost.

3. Effective annual rate A financial institution made a $10,000, 1-year discount loan at 10% interest, requiring a compensating balance equal to 20% of the face value of the loan. Determine the effective annual rate associated with this loan. (Note: Assume that the firm currently maintains $0 on deposit in the financial institution.)

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Solution Summary

This solution shows step-by-step calculation in an Excel file to determine the effects of the credit relaxation, the net costs in a zero-balance account and the effective annual rate.

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