Extensive Enterprise Inc. is a relatively small player in its market. Its new Chief Financial Officer (CFO), Kayin Alexander, has suggested that its credit policy may be one possible source of the companys lower-than-desired sales. This is because Extensive currently sells all of its product on either a cash on delivery (COD) or a cash before delivery (CBD) basis, depending upon the buying volume of the customer. Kayin observed that one possible strategy to increase Extensives sales is to offer trade credit to its most creditworthy customers.

Offering trade credit will involve both risks and returns to Extensive. Indicate which of the following statements regarding these risks and returns are true or false.

An added cost associated with the offering of credit terms is the requirement for a credit investigation of Extensives credit customers.

This statement is:

False

True

The availability of trade credit is beneficial to those customers of Extensive that might not otherwise be able to qualify for bank credit. This should increase Extensives sales.

This statement is:

True

False

Last week, Kayin met with several of the firms larger, more creditworthy customers, including the Allied Biscuit Company (ABC). In the course of this meeting, he suggested terms of 1/10 net 20, but two things became quickly apparent:

	Not everyone remembered how to calculate the cost of trade credit, so a review of the equation should be conducted; and
	While everyone acknowledged that these terms are consistent with the industrys standards, they are concerned with the magnitude of the implicit costs associated with paying on various dates throughout the credit period.

Therefore, you need to do two things:

	Identify the individual elements in the annual financing cost of trade credit equation; and
	Calculate the implicit costs of paying on several dates throughout Extensives credit period.

Begin with the identification of the variables in the annual financing cost of trade credit equation. Then, use the equation to compute the annual financing cost of the trade credit assuming that the invoices are paid on the indicated days. Remember, Kayin suggested terms of 1/10 net 20.

Cost of Trade Credit

=

Variable A(100 Variable C)Variable A(100 Variable C) x Variable E(Variable B Variable D)Variable E(Variable B Variable D)

Variable	Identity of the Variable
A
B
C
D
E

Payment Date	Cost of Trade Credit
Day 10
Day 11
Day 20
Day 30 (Two weeks late)

Looking at the trend in the implicit costs of trade credit in the preceding table, what can you conclude about these costs? Read the following statement and determine if it is true or false.

If a customer decides to forgo the cash discount, then he should make his payment on the day after its expiration if he wants to minimize the cost of his trade credit.

This statement is:

True

False