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Case 2 Questions

This document contains a series of questions analyzing financial statements for a company called Fresh & Fruity. It calculates the company's average collection period, cost of not taking supplier discounts, effect of reducing accounts receivable, cash flow impact of taking more discounts, minimum size of a loan to take all discounts, and net gain from discounts versus interest on the loan. It also calculates the effective annual interest rate if the loan requires a compensating balance.

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Iqra Ali
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154 views

Case 2 Questions

This document contains a series of questions analyzing financial statements for a company called Fresh & Fruity. It calculates the company's average collection period, cost of not taking supplier discounts, effect of reducing accounts receivable, cash flow impact of taking more discounts, minimum size of a loan to take all discounts, and net gain from discounts versus interest on the loan. It also calculates the effective annual interest rate if the loan requires a compensating balance.

Uploaded by

Iqra Ali
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Questions:

a. Using the data in the income statement and the balance sheet that:

compute the company’s average collection period (ACP) in days. Use a 365-
day year when calculating sales per day.

= $209,686.00/ ($1,179,000.00/365 Days)


= 65 Days

b. Compute the cost, as a percent, that the company is paying for not taking the
suppliers’ discounts. (The suppliers’ terms are 2/10, net 60.

= [(2%/98%) x (365 Days/ (60 Days – 10 Days)] x 100


= 14.90%

c. Assume Alice Plummer’s first initiative to offer a 10 percent discount was


implemented, and the company’s average collection period dropped to 32
days. If net sales per day remained the same, as Alice expects, what would
be the new accounts receivable balance?

Net sales per days = $1,179,000.00/365 = $3,230.14 per day

= $3,230.14 x 32 Days

New Balance = $103,364.38

How much cash was freed up by the reduction in accounts receivable?

=$209,868.00 - $103,364.38

=$106,321.62

What is the new accounts payable balance if the money is used to pay off
suppliers?

=$180,633.00 - $106,321.62

=$74,311.38

d. As a result of Alice’s first initiative described in part c, Fresh & Fruity is


able to take advantage of the 2 percent discount on one-third of its purchases
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(see the income statement).

What will be the cash discount figure on the income statement?

=$969,000.00 x 1/3

=$323,000.00 x 2%

=$ 6,460.00 Cash Discount

What effect does this have on net income (after taxes)?

An increase in net income

Also what is the effect on the return-on-sales ratio shown toward the bottom
of the balance sheet? Consider the effect on the return-on-equity ratio as
well.

e. Alice’s second initiative calls for Fresh & Fruity to obtain a bank loan of a
sufficient size to enable the company to take all suppliers’ discounts.

What is the minimum size of this loan?

Average purchases per day = $969,000.00/365 days = $2654.80

Accounts Receivables =$969,000.00 – ($969,000.00 x 2%)

=$949,620.00

Accounts Payable = 10 Days x $2,654.80

= $26,548.00
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Therefore, size of loan = $74,311.38 - $26,548.00 = $47,763.38

f. Assume Fresh & Fruity obtains an 8 percent loan for one year in the amount
you solved in part e, and it reduces its accounts payable balance accordingly.
Now the company is taking 2 percent discounts on all purchases and paying
8 percent a year on the loan balance.

What is the net gain from taking the discounts and paying the interest on a
before-tax basis? (on an after tax basis?)

(i) = 8% x $47,763.38 = $ 3,821.07

(ii) = 2% x $969,000.00 = $ 19,380.00

(iii) Therefore, $19,380.00 - $3,821.07 = $ 15,558.93

g. Suppose the 8 percent loan that Fresh & Fruity obtained was a discount loan,
and the bank further required a 20 percent compensating balance of the full
loan amount.

What is the annual rate of interest to Fresh & Fruity?

How does this compare to your answer in question b for the cost of not
taking a cash discount?

47,763.38-(8% x $47,763.38) = $43,942.31


43,942.31-(20% x $47,763.38) = $34,767
Annual rate of interest =

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