1. Langley Clinics, Inc. buys $400,000 in medical supplies a year (at gross prices) from its major supplier, Consolidated Services, which offers Langley terms of 2.5/10, net 45. Currently, Langley is paying the supplier the full amount due on Day 45, but it is considering taking the discount, paying on Day 10, and replacing the trade credit with a bank loan that has a 10 percent annual cost.
a. What is the amount of free trade credit that Langley obtains from Consolidated Services? (Assume 360 days per year throughout this problem.)
b. What is the amount of costly trade credit?
c. What is the approximate annual percentage cost of the costly trade credit?
d. Should Langley replace its trade credit with the bank loan? Explain your answer.
e. If the bank loan is used, how much of the trade credit should be replaced?
2. Milwaukee Surgical Supplies, Inc. sells on terms of 3/10, net 30. Gross sales for the year are $1,200,000, and the collections department estimates that 30 percent of the customers pay on the tenth day and take discounts; 40 percent pay on the thirtieth day; and the remaining 30 percent pay, on average, 40 days after the purchase. (Assume 360 days per year.)
a. What is the firm's average collection period?
b. What is the firm's current receivables balance?
c. What would be the firm's new receivables balance if Milwaukee Surgical toughened up on its collection policy, with the result that all nondiscount customers paid on the 30th day?
d. Suppose that the firm's cost of carrying receivables was 8 percent annually. How much would the toughened credit policy save the firm in annual receivables carrying expense? (Assume that the entire amount of the receivables had to be financed.)
3. a. Modern Medical Devices has a current ratio of 0.5. Which of the following actions would improve (i.e., increase) this ratio?
- Use cash to pay off current liabilities.
- Collect some of the current accounts receivable.
- Use cash to pay off some long-term debt.
- Purchase additional inventory on credit (i.e., accounts payable).
- Sell some of the existing inventory at cost.
b. Assume that the company has a current ratio of 1.2. Now, which of the above actions would improve this ratio?