Question

Use the following information to answer the next two questions.  

X-ray Inc. is a small manufacturing company. Currently, X-ray extends credit to its customers on a net 45 basis, but the company is having an issue with collecting payments in a timely manner. Currently, X-ray's customers pay 90 days (n=90) after being invoiced. X-ray is currently contemplating giving customers a 5% discount if they pay within 20 days of the invoice date. Currently, the average invoice amount is $12,000, but the company believes that the average invoice will grow to $12,300 if it provides a 5% discount. Futhermore, X-ray believes that 60% of its customers will pay in exactly 20 days (DSO=20) if the discount is introduced, while the remaining 40% will continue to pay 90 days after being invoiced. X-ray's annual cost of capital is 15%

What is the current present value of the average invoiced received by the corporation (ignoring the potential discount)? Round intermediate steps to four decimals.

		10,145.63
		13,018.32
		11,571.84
		11,782.03

5 points   

QUESTION 19

Does it make financial sense for the company to pursue the 5% discount policy? Round intermediate steps to four decimals.

		Yes
		No
		X-ray would be indifferent between using the discount policy and not issuing it.
		Cannot be determined.

5 points   

QUESTION 20

The cash conversion cycle must be positive since it is measured in days.

True

False

Answer 1

Question 18:

The annual cost of capital is 15% (for 365 days)

Cost of capital for 90 days = 0.15*90/365 = 0.036986 or 3.6986%

Current average invoice = 12,000

Present value of the ivoice = 12,000(1+0.036986) = 11,571.84 (Option C)

Question 19:

Effective cost of trade credit = Discount %/(100- Discount %) * 365/(total days - discount days) = 5%/(100-5%)* 365/(90-20) = 0.2744 = 27.44%

Since the cost of trade credit is greater than the cost of capital 15%, it does not make financial sense . Answer is NO

Question 20:

FALSE

Reason : Cash conversion cycle = DSO + DIO - DPO. If the days sales and days inventory is low and days payable is very high, the cash conversion cycle can be neagtive. For example, Amazon has a negative cash conversion cycle