Chapter21 •Credit and Inventory Management McGraw-Hill/Irwin Copyright © by The McGraw-Hill Companies, Inc All rights Chapter 21 – Index of Sample Problems • • • • • • • • • • Slide # 02 - 03 Slide # 04 - 06 Slide # 07 - 09 Slide # 10 - 11 Slide # 12 - 13 Slide # 14 - 15 Slide # 16 - 21 Slide # 22 - 25 Slide # 26 - 27 Slide # 28 - 30 Accounts receivable Discount terms Credit policy switch Switch break-even point One-time sale Repeat sale Economic order quantity (EOQ) One-shot approach Accounts receivable approach Discounts and default risk 2: Accounts receivable Over the past five years, your firm has had average daily sales of $26,780 The average collection period is 34 days What is the average accounts receivable balance you would expect to find if you analyzed the monthly balance sheets of your firm? 3: Accounts receivable Average accounts receivable = Average daily sales × Average collection period = $26,780 × 34 = $910,520 4: Discount terms Today, June 10, you purchased $5,000 worth of materials from one of your suppliers The terms of the sale are 3/15, net 45 What is the discounted price? By what day you have to pay to receive the discount? What is the effective annual rate of the discount? 5: Discount terms Discounted price = $5,000 × (1 - 03) = $5,000 × 97 = $4,850 Final day for discount = June 10 + 15 days = June 25 6: Discount terms Days in period = 45 - 15 = 30 Periods per year = 365 = 12.1667 30 03 × $5,000 Interest rate for 30 days = (1 - 03) × $5,000 $150 = $4,850 = 03093 Effective annual rate = (1 + 03093)12.1667 − = 44862 = 44.86% 7: Credit policy switch Currently, your firm has a cash only policy Under this policy, your monthly sales are 70 units at a selling price of $50 a unit The variable cost is $34 a unit You are trying to decide if you want to change your credit policy to net 30 You estimate that if you switch your credit policy that your monthly sales will increase to 90 units The applicable monthly interest rate is 5% What is the incremental cash inflow from the proposed switch in your credit policy? What is the net present value of the proposed switch? 8: Credit policy switch Incremental cash inflow = (P - v)(Q'-Q) = ($50 − $34)(90 − 70) = $16 × 20 = $320 9: Credit policy switch (P − v)(Q'−Q) NPV = −[(PQ + v(Q'−Q)] + R ($50 − $34) × (90 − 70) = −[($50 × 70) + $34 × (90 − 70)] + 005 $320 = −[$3500 + $680] + 005 = −$4,180 + $64,000 = $59,820 17: Economic Order Quantity (EOQ) EOQ = 2T × F CC = × 31,200 × $75 $1.10 = $4,680,000 $1.10 = 4,254,545.46 = 2,062.65 units 18: Economic Order Quantity (EOQ) You sell 12,000 units of a product each year at an average price of $15 each Your variable cost per unit is $9 Your carrying cost per unit is $.60 You allow your inventory of this product to drop to zero before restocking Each order you place is for 2,500 units The fixed cost per order is $40 What is your annual total carrying cost? What is your annual total restocking cost? What is the EOQ? 19: Economic Order Quantity (EOQ) Total carrying cost = Average inventory × Carrying cost per unit 2,500 + = × $.60 = 1,250 × $.60 = $750 12,000 × $40 2,500 = 4.8 × $40 Total restocking cost = = $192.00 20: Economic Order Quantity (EOQ) EOQ = = 2T × F CC × 12,000 × $40 $.60 $960,000 = $.60 = 1,600,000 = 1,264.91 21: Economic Order Quantity (EOQ) Total carrying cost = Average inventory × Carrying cost per unit 1,264.91 + = × $.60 = 632.455 × $.60 = $379.47 12,000 × $40 1,264.91 = 9.48684 × $40 = $379.47 Total restocking cost = 22: One-shot approach Your firm currently sells 200 units each month at a price of $24 each The variable cost per unit is $14 and the monthly interest rate is 1.5% If you switch your credit policy from cash only to net 30, you think you can increase your sales to 215 units a month Use the one-shot approach to compute the NPV of the switch 23: One-shot approach Current net income = (P - v) × Q = ($24 - $14) × 200 = $2,000 24: One-shot approach Proposed income = P × Q' = $24 × 215 = $5,160 Proposed cost = v × Q' = $14 × 215 = $3,010 $5,160 Proposed NPV = - $3,010 + + 015 = −$3,010 + $5,083.74 = $2,073.74 25: One-shot approach Monthly gain from switch = $2,073.74 - $2,000 = $73.74 NPV of switch = $73.74 + $73.74 015 = $4,989.74 = $4,990 26: Accounts receivable approach Your firm currently sells 200 units each month at a price of $24 each The variable cost per unit is $14 and the monthly interest rate is 1.5% If you switch your credit policy from cash only to net 30, you think you can increase your sales to 215 units a month Use the accounts receivables approach to compute the NPV of the switch 27: Accounts receivable approach (P − v)(Q'−Q) − {[PQ + v(Q'−Q)] × R} R [($24 − $14) × (215 − 200)] − {[($24 × 200) + $14 × (215 − 200)] × 015} = 015 [$10 × 15] − {[$4,800 + $210] × 015} = 015 $150 − $75.15 = 015 $74.85 = 015 = $4,990 PV = 28: Discounts and default risk Currently, you sell 50 units per period at $22.50 a unit You are considering implementing a net 30 credit policy along with increasing your credit price to $24 If you make this change, you expect that your sales will remain at their current level You also expect all of your customers to take advantage of the credit period and that 2% of them will default The applicable monthly interest rate is 1.5% What is the net present value of this proposed credit policy? What is the break-even default rate? 29: Discounts and default risk P'−P P' $24.00 − $22.50 = $24.00 = 0625 d= = 6.25% d −π NPV = −PQ + P' Q × R = −($22.50 × 50) + ($24 × 50) × = −$1,125 + $3,400 = $2,275 0625 − 02 015 30: Discounts and default risk π = d − R × (1 − d ) = 0625 − 015 × (1 − 0625) = 0625 − 0141 = 0484 = 4.84% Chapter21 •End of Chapter 21 McGraw-Hill/Irwin Copyright © by The McGraw-Hill Companies, Inc All rights ... also expect all of your customers to take advantage of the credit period and that 2% of them will default The applicable monthly interest rate is 1.5% What is the net present value of this proposed... You sell 12,000 units of a product each year at an average price of $15 each Your variable cost per unit is $9 Your carrying cost per unit is $.60 You allow your inventory of this product to drop... $910,520 4: Discount terms Today, June 10, you purchased $5,000 worth of materials from one of your suppliers The terms of the sale are 3/15, net 45 What is the discounted price? By what day