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Solutions to Problems
December 25
December 30
January 9
January 30
= 37.24%
= 18.43%
= 21.28%
= 32.25%
= 7.37%
= 56.44%
= 8.95%
CD
365
100% CD N
1%
365
Cost of giving up cash discount =
100% 1% 30
Cost of giving up cash discount = 0.0101 12.17 = 0.1229 = 12.29%
2%
365
100% 2% 20
Cost of giving up cash discount = 0.0204 18.25 = 0.3723 = 37.23%
Cost of giving up cash discount =
2%
365
100% 2% 21
Cost of giving up cash discount = 0.0204 17.38 = 0.3646 = 36.46%
Cost of giving up cash discount =
1%
365
100% 1% 50
Cost of giving up cash discount = 0.0204 7.3 = 0.1489 = 14.89%
Cost of giving up cash discount =
(d) In all four cases the firm would be better off to borrow the funds and take the discount. The
annual cost of not taking the discount is greater than the firms 8% cost of capital.
P15-4. LG 1: Cash Discount versus Loan
Basic
Cost of giving up cash discount = (0.03 0.97) (365 35) = 32.25%
Since the cost of giving up the discount is higher than the cost of borrowing for a short-term loan,
Erica is correct; her boss is incorrect.
P15-5. LG 1, 2: Cash Discount Decisions
Intermediate
(a)
(b)
Supplier
Decision
Borrow
Give up
Give up
Borrow
Prairie would have lower financing costs by giving up Ks and Ls discount since the cost of
forgoing the discount is lower than the 16% cost of borrowing.
(c) Cost of giving up discount from Supplier M = (0.03 0.97) (365 75) = 15.05% In this
case the firm should give up the discount and pay at the end of the extended period.
P15-6. LG 2: Changing Payment Cycle
Basic
Annual Savings = ($10,000,000) (0.13) = $1,300,000
$10,000 0.10
= 14.29%
[$10,000 (1 0.10 0.20)]
= $120,000 $70,000
= $50,000
$88, 000
=
= 11.73%
$800, 000 $50, 000
= 11%
(None of the $800,000 borrowed is required to satisfy the compensating balance requirement.)
(d) The lowest effective interest rate occurs in situation (c), when Lincoln has $150,000 on
deposit. In situations (a) and (b), the need to use a portion of the loan proceeds for
compensating balances raises the borrowing cost.
$1,000,000 $978,000
= 2.25%
$978,000
Amount
$8,000
50,000
12,000
46,000
22,000
62,000
$200,000
Amount
$20,000
2,000
12,000
27,000
19,000
$80,000
Interest cost =
$7,750
= 7.75% for 6 months
$100,000
Interest cost =
$4,875
= 4.88% for 3 months
$100,000
P15-17. LG 5: Factoring
Intermediate
Holder Company
Factored Accounts
May 30
Accounts
A
B
C
D
E
F
G
H
Amount
$200,000
90,000
110,000
85,000
120,000
180,000
90,000
30,000
Date Due
5/30
5/30
5/30
6/15
5/30
6/15
5/15
6/30
Status on
May 30
C 5/15
U
U
C 5/30
C 5/27
C 5/30
U
C 5/30
Amount
Remitted
$196,000
88,200
107,800
83,300
117,600
176,400
88,200
29,400
Date of
Remittance
5/15
5/30
5/30
5/30
5/27
5/30
5/15
5/30
The factor purchases all acceptable accounts receivable on a nonrecourse basis, so remittance is
made on uncollected as well as collected accounts.
P15-18. LG 1, 6: Inventory Financing
Challenge
(a) City-Wide Bank:
[$75,000 (0.12 12)] +(0.0025 $100,000) = $1,000
Sun State Bank:
$100,000 (0.13 12) = $1,083
Citizens Bank and Trust: [$60,000 (0.15 12)] + (0.005 $60,000) = $1,050
(b) City-Wide Bank is the best alternative, since it has the lowest cost.
(c) Cost of giving up cash discount = (0.02 0.98) (365 20) = 37.24%
The effective cost of taking a loan = ($1,000 $75,000) 12 = 16.00%
Since the cost of giving up the discount (37.24%) is higher than borrowing at Citywide Bank
(16%), the firm should borrow to take the discount.
P15-19. Ethics Problem
Intermediate
Management should point out that what it is doing shows integrity, as it is honest, just and fair.
The ethics reasoning portrayed in the ethics focus box could be used.