a. Assume that, on average, the brothers expect annual sales of 18,000 items at an average price of $100 per item. (use a 365 day year.)

(1) What is the firm's expected days sales outstanding (DSO)?

(2) What is its expected average daily sales (ADS)?

(3) What is its expected average accounts receivable (AR) level?

(4) Assume that the firm's profit margin is 25 percent. How much of the receivables balance must be financed? What would the firm's balance sheet figures for accounts receivable, notes payable, and retained earnings be at the end of one year if notes payable are used to finance the investment in receivables? Assume that the cost of carrying receivables had been deducted when the 25 percent profit margin was calculated.

(5) If loans have a cost of 12 percent, what is the annual dollar cost of carrying the receivables?

b. What are some factors which influence

(1) A firm's receivables level and

(2) The dollar cost of carrying receivables?

c. Assuming that the monthly sales forecasts given previously are accurate, and that customers pay exactly as was predicted, what would the receivables level be at the end of each month? To reduce calculations, assume that 30 percent of the firm's customers pay in the month of sale, 50 percent pay in the second month following the sale, and the remaining 20 percent pay in the second month following the sale. Note that this is a different assumption than was made earlier.

d. What is the firm's forecasted average daily sales for the first 3 months? For the entire half-year? The days sales outstanding is commonly used to measure receivables performance. What DSO is expected at the end of March? At the end of June? What does the DSO indicate about customers' payments? Is DSO a good management tool in this situation? If not, why not?

e. Construct aging schedules for the end of March and the end of June. Do these schedules properly measure customers' payment patterns? If not, why not?

f. Construct the uncollected balances schedules for the end of March and the end of June. Do these schedules properly measure customers' payment patterns?

g. Assume that it is now July of Year 1, and the brothers are developing pro forma financial statements for the following year. Further, assume that sales and collections in the first half-year matched the predicted levels. Using the year 2 sales forecasts as shown next, what are next year's pro forma receivables levels for the end of march and for the end of June?

h. Assume now that it is several years later. The brothers are concerned about the firm's current credit terms, which are now net 30, which means that contractors buying building products from the firm are not offered a discount, and they are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80 percent (by dollar volume) of the firms paying customers generally pay the full amount on day 30, while the other 20 percent pay, on average, on day 40. Two percent of the firm's gross sales end up as bad debt losses.

i. Under the current credit policy, what is the firm's days sales outstanding (DSO)? What would the expected DSO be if the credit policy change were made?

j. What is the dollar amount of the firm's current bad debt losses? What losses would be expected under the new policy?

k. What would be the firm's expected dollar cost of granting discounts under the new policy?

l. What is the firm's current dollar cost of carrying receivables? What would it be after the proposed change?

m. What is the incremental after-tax profit associated with the change in credit terms? Should the company make the change? (assume a tax rate of 40 percent.)

n. Suppose the firm makes the change, but its competitors react by making similar changes to their own credit terms, with the net result being that gross sales remain at the current $1,000,000 level. What would the impact be on the firm's post-tax profitability?

o. The brothers need $100,000 and are considering a 1-year bank loan with a quoted annual rate of 8%. The bank is offering the following alternatives: (1) simple interest, (2) discount interest, (3) discount interest with a 10% compensating balance, and (4) add-on interest on a 12-month installment loan. What is the effective annual cost rate for each alternative? For the first three of these assumptions, what is the effective rate if the loan is for 90 days, but renewable? How large must the face value of the loan amount actually be in each of the 4 alternatives to provide $100,000 in usable funds at the time the loan is originated?

Rich Jackson, a recent finance graduate, is planning to go into the wholesale building supply business with his brother, Jim, who majored in building construction. The firm would sell primarily to general contractors, and it would start operating next January. Sales would be slow during the cold months, rise during the spring, and then fall off again in the summer, when new construction in the area slows. Sales estimates for the first 6 months are as follows (in thousands of dollars):

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March $300 June $100 January February $100 $200 April $300 May $200