CMA Study Group

 Hey guys .. How u doing ? I havent been actively using my ima account for a while.

I guess , I am back now with some doubts .. And need help

I study my course using Gleim Material , And I have found some difficulties .

Q1)

The High cost of short-term Financing has recently caused a company to re-evaluate the terms of credit it extends to its customers. The current policy is 1/10, net 60.
Customers can borrow at the prime rate. Which of the following prime rates would induce the company to changes its terms of credit in order to avoid an undesirable extension in its collection of receivables ?

a) 5%
b) 8%
c) 2%
d) 7%

The Answer is b - 8%

Explanation Needed !!

Thanks

Hi Anesh,

The interest rate currently paid by customers is the cost of not taking a discount. The formula is:

(Discount % / 1-Discount %) x [Days in year / (collection period - discount period)]

This would be  (.01/.99) x (360/50) = .072727273 or 7.27 %

If the prime rate were anything greater than this, many customers would not have a big enough incentive to take the discount because they are still paying less interest than the prime rate without taking the discount. If the prime rate were 2,5,or 7% the customer would want to take the discount in order to lower the amount of interest paid above the prime rate. Hope this helps.

Regards,

Aaron Copeland

 Thanks Aaron ..

It helps

Another Question

Q)

Richardson Supply has a $100 invoice with payment terms of 2/10, net 60. Richardson can either take the discount or place the funds in a money market account paying 6% interest.
Using a 360-day year, Richardson's cost of not taking the cash discount is

a) 6.4 %
b) 6.2 %
c) 8.7 %
d) 12.2%

Answer c

Explanation need

Hi Anesh,

The annual cost of not taking the discount (ignoring money market interest) is:

(.02/.98) x (360/50) = .146938776 or 14.69 %

Since the money retained from not taking the discount can be invested throughout the year at 6% interest in the money market fund, the actual cost of not taking the cash discount would be:

.146938776 - .06 = .086938776 or 8.7%

Regards,

Aaron Copeland