##### ASSUMPTIONS Balance Sheets (current assets shaded) 2007 2008 2009-(Answered)

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**Question**

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B. What impact does this transaction have on the firm?s current ratio if the intial current ratio is 0.5? | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||

C. What impact does this transaction have on the firm?s current ratio if the initial current ratio equaled 1.7? |

4. Mississippi Delta, Inc. has been selling switching equipment to computer companies on net-30 terms, in which payment is expected by 30 days from the invoice date. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes:

Prompt payors and laggards. Prompt payors (80 percent of Mississippi Delta?s customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2 percent cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takes (who would then pay only 98% of the invoiced dollar amount) justifies the improved collection. The company?s annual cost of capital is 11%.

A.) Using NPV calculations, show the PV of the present collection experience.

B.) Calculate the NPV of the proposed 2/10, net-30 terms.

C.) Based on your NPV analysis, should Mississipi Delta Inc. adopt the cash discount?

D.) What other factors should be taken into account before Mississippi Delta Inc. makes a switch, assuming such is justifiable on an NPV basis?

E.) Sensivity analysis involves varying the key assumptions, one at a time, and observing the effect on the key decision criterion-such as profits or NPV. In the NPV analysis above, how could could one carry out sensitivity analysis? (If you have a financial spreadsheet available, conduct a sensitivity analysis that varies the number of prompt payors who will pay in exactly 10 days and report your findings.)

ASSUMPTIONS

(current assets shaded)

Cash & Equivalents

Accounts Receivable

Inventory

Net Fixed Assets

2007

$75

300

150

525

Total Assets

$1,050

(current liabilities shaded)

Accounts Payable

$125

Notes Payable

165

Accrued Operating Exp.

60

Long-Term Debt

500

Shareholders Equity

200

Total Liabilities & NW

$1,050

Balance Sheets

2008

$75

400

250

575

$1,300

$175

162

161

400

402

$1,300

Income Statements

2009

$90

600

350

610

$1,65

0

$250

178

165

300

757.2

$1,65

0

2010

$100

550

250

540

2011

$100

500

250

465

$1,440

$1,315

$225

136

89

100

890.2

$200

99

76

50

890.2

$1,440

$1,315

$3,00

Revenues (Sales)

$1,500

$2,250

0

$2,000 $1,500

Cost of Goods Sold

600

900

1200

800

600

Operating Expenses

600

797

895

750

725

Depreciation

35

50

65

70

75

Interest

30

33

28

25

10

Taxes

94

188

325

142

36

Net Profit

141

282

487.2

213

54

Dividends

40

80

132

80

54

2.) Suppose a firm pays a $50,000 trade credit obligation to a supplier in cash.

A. What impact does this transaction have on the firm's current ratio if the initial current ratio equaled 1?

B. What impact does this transaction have on the firm?s current ratio if the intial current ratio is 0.5?

C. What impact does this transaction have on the firm?s current ratio if the initial current ratio equaled 1.7?

4. Mississippi Delta, Inc. has been selling switching equipment to computer companies on net-30 terms,

in which payment is expected by 30 days from the invoice date. Concerned about deteriorating

collection patterns, the credit manager has divided customers into two groups for examination purposes:

Prompt payors and laggards. Prompt payors (80 percent of Mississippi Delta?s customers) pay,

on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the

credit terms should be modified to include a 2 percent cash discount on invoices paid within 10

days. The average invoice is the same for both groups, roughly $4,000. The manager expects

50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to

40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will

slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takes

(who would then pay only 98% of the invoiced dollar amount) justifies the improved collection.

The company?s annual cost of capital is 11%.

A.) Using NPV calculations, show the PV of the present collection experience.

B.) Calculate the NPV of the proposed 2/10, net-30 terms.

C.) Based on your NPV analysis, should Mississipi Delta Inc. adopt the cash discount?

D.) What other factors should be taken into account before Mississippi Delta Inc. makes a switch,

assuming such is justifiable on an NPV basis?

E.) Sensivity analysis involves varying the key assumptions, one at a time, and observing the effect on the

key decision criterion-such as profits or NPV. In the NPV analysis above, how could could one carry out

sensitivity analysis? (If you have a financial spreadsheet available, conduct a sensitivity analysis that

varies the number of prompt payors who will pay in exactly 10 days and report your findings.)

Paper#9210129 | Written in 27-Jul-2016

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