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# Bad Debt Ratios for Universal Bed Corporation

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1. As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6 percent. He believes that imposing a more stringent credit policy might reduce sales by 5 percent and reduce the bad debt ratio to 4 percent. If the cost of goods sold is 80 percent of the selling price, should Mr. Procrustes adopt the more stringent policy?

2. Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of \$180 million annually. First National, Knob's principal bank, offers to establish a new concentration banking system for a flat fee of \$100,000 per year. The bank estimates that mailing and collection time can be reduced by three days. By how much will Knob's cash balances be increased under the new system? How much extra interest income will the new system generate if the extra funds are used to reduce borrowing under Knob's line of credit with First National? Assume that the borrowing rate is 12 percent. Finally, should Knob accept First National's offer if collection costs under the old system are \$40,000 per year?

#### Solution Summary

Bad debt ratios for Universal Bed Corporation is analyzed. It is determined if more stringent policy is needed.

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## Accounting equation; inventory holding costs; credit policies; times interest earned

Question 1
How would the following errors affect the account balances and the basic accounting equation, Assets = Liabilities + Owners' Equity? How do the misstatements affect income?

1. The purchase of a truck is recorded as an expense instead of an asset.
2. A cash payment on accounts receivable is received but not recorded.
3. Fictitious sales on account are recorded.
4. A clerk misreads a handwritten invoice for repairs and records it as \$1,500 instead of \$1,800.
5. Payment is received on December 31 for the next three months' rent and is recorded as revenue.

Question 2
Brady Company sells imported goods made in India. One product it sells is a wooden music box. The music boxes cost Brady \$65, and Brady charges its customers a price of \$250.Brady's cost of capital is 12%. On average, an entire year elapses between the time Brady pays for a music box and the time Brady collects the cash from the sale of the music box. What are Brady's annual financial holding costs per unit for the wooden music boxes?

Question 3
As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6 percent. He believes that imposing a more stringent credit policy might reduce sales by 5 percent and reduce the bad debt ratio to 4 percent. If the cost of goods sold is 80 percent of the selling price, should Mr. Procrustes adopt the more stringent policy?

Question 4
In the past year, TVG had revenues of \$3 million, cost of goods sold of \$2.5 million, and depreciation expense of \$200,000. The firm has a single issue of debt outstanding with face value of \$1 million, market value of \$.92 million, and a coupon rate of 8 percent. What is the firm's times interest earned ratio?

Question 5
Lever Age pays an 8 percent coupon on outstanding debt with face value \$10 million. The firm's EBIT was \$1 million.

1. What is times interest earned?
2. If depreciation is \$200,000, what is cash coverage?
3. If the firm must retire \$300,000 of debt for the sinking fund each year, what is its "fixed payment cash-coverage ratio" (the ratio of cash flow to interest plus other fixed debt payments)?

Question 6
Rulon Wilcox is the president of Wilcox Company, and his brother, Harry Wilcox, is the vice president. Their compensation package includes bonuses of 4% for Rulon Wilcox and 3% for Harry Wilcox of net income that exceeds \$250,000. Net income for the year 2006 has just been computed to be \$885,000.