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Trade Credit Rates

1. Trade Credit Rates. Company X sells on a 1/20, net 60, basis. Customer Y buys goods with an invoice of $1,000.

a. How much can Company Y deduct from the bill if it pays on Day 20?

b. How many extra days of credit can Company Y receive if it passes up the cash discount?

c. What is the effective annual rate of interest if Y pays on the due date rather than Day 20?

2. Terms of Sale. Complete the following passage by selecting the appropriate terms from the following list (some terms may be used more than once): acceptance, open, commercial, trade, the United States, his or her own, note, draft, account, promissory, bank, banker`s, the customer`s.

Most goods are sold on ________ ________. In this case the only evidence of the debt is a record in the seller`s books and a signed receipt. When the order is very large, the customer may be asked to sign a(n) ________ ________, which is just a simple IOU. An alternative is for the seller to arrange a(n) ________ ________ ordering payment by the customer. In order to obtain the goods, the customer must acknowledge this order and sign the document. This signed acknowledgment is known as a(n) ________ ________. Sometimes the seller may also ask ________ ________ bank to sign the document. In this case it is known as a(n)

________ ________.

3. Terms of Sale. Indicate which firm of each pair you would expect to grant shorter or longer credit periods:

a. One firm sells hardware; the other sells bread.

b. One firm`s customers have an inventory turnover ratio of 10; the other`s customers have turnover of 15.

c. One firm sells mainly to electric utilities; the other to fashion boutiques.

4. Payment Lag. The lag between purchase date and the date at which payment is due is known as the terms lag. The lag between the due date and the date on which the buyer actually paysis termed the due lag, and the lag between the purchase and actual payment dates is the pay lag. Thus Pay lag = terms lag + due lag

State how you would expect the following events to affect each type of lag:

a. The company imposes a service charge on late payers.

b. A recession causes customers to be short of cash.

c. The company changes its terms from net 10 to net 20.

5. Bankruptcy. True or false?

a. It makes sense to evaluate the credit manager`s performance by looking at the proportion of bad debts.

b. When a company becomes bankrupt, it is usually in the interests of the equity holders to seek a liquidation rather than a reorganization.

c. A reorganization plan must be presented for approval by each class of creditor.

d. The Internal Revenue Service has first claim on the company`s assets in the event of bankruptcy.

e. In a reorganization, creditors may be paid off with a mixture of cash and securities.

f. When a company is liquidated, one of the most valuable assets to be sold is often the taxloss carry-forward.

6. Trade Credit Rates. A firm currently offers terms of sale of 3/20, net 40. What effect will the following actions have on the implicit interest rate charged to customers that pass up the cash discount? State whether the implicit interest rate will increase or decrease.

a. The terms are changed to 4/20, net 40.

b. The terms are changed to 3/30, net 40.

c. The terms are changed to 3/20, net 30.