Effective Cost Of Trade Credit: The DJ Masson Corporation Ne

effective Cost Of Trade Creditthe Dj Masson Corporation Needs To R

Effective Cost of Trade Credit The D.J. Masson Corporation needs to raise $700,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 2/10, net 90, and it currently pays on the 10th day and takes discounts. However, it could forgo discounts, pay on the 90th day, and get the needed $700,000 in the form of costly trade credit. What is the effective annual interest rate of this trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.

Sample Paper For Above instruction

The effective cost of trade credit is crucial for understanding the financial implications when a company chooses between early payment discounts and delaying payments. In the context of D.J. Masson Corporation, which needs to raise $700,000 for a year, analyzing the cost of forgoing early discounts offers insights into the actual interest rate incurred by delaying payments.

Initially, Masson takes advantage of the 2% discount if it pays within 10 days. The discount terms are 2/10, net 90, indicating that if payment is made within ten days, a 2% discount applies. Traditionally, the company pays on the 10th day, availing of this benefit. However, by postponing the payment until the 90th day, the company effectively forgoes the discount, incurring a higher cost of trade credit.

Calculating the interest rate involves comparing the savings from the discount against the amount paid if paid late. The discount amount is 2% of $700,000, which equals $14,000. If Masson exercises the discount, the effective payment is $686,000, and the cost of the trade credit is the interest paid on the $700,000 for 80 days (from day 10 to day 90).

The interest for the period is calculated as: (discount amount) / (payment after discount) = $14,000 / $686,000 ≈ 0.02043 or 2.043%. To annualize this, we adjust for the period: (1 + 0.02043)^(365/80) - 1 ≈ (1.02043)^(4.5625) - 1 ≈ 1.0957 - 1 = 0.0957 or 9.57%. Hence, the effective annual interest rate of forgoing the discount and paying on the 90th day is approximately 9.57%.

This rate highlights the costlier finance charge associated with delaying payments past the discount period, emphasizing the importance of early payment when feasible. Businesses must evaluate these costs against alternative funding options to optimize cash flow and expenses.

Interest Rate Parity

Assuming interest rate parity holds, the forward exchange rate between two currencies is determined by the spot rate and the interest rates in both countries. Given that in both the spot and 90-day forward market, 1 Japanese yen equals 0.009 dollars, and the 90-day risk-free security yield in Japan is 4.1%, we can find the U.S. risk-free interest rate using the interest rate parity formula:

Forward rate / Spot rate = (1 + interest rate in foreign country) / (1 + interest rate in domestic country)

Rearranged, the U.S. interest rate is:

Interest_US = [(Forward rate / Spot rate) * (1 + interest_rate_Japan)] - 1

Since the forward rate equals the spot rate (both 0.009), the formula simplifies to:

Interest_US = (1 + 0.041) - 1 = 0.041 or 4.10%.

Foreign Capital Budgeting

Assessing the net present value (NPV) of a U.S.-based project involves discounting the cash flows at the project's risk-adjusted cost of capital, 10%. The initial investment is $1 million, with inflows of $700,000 in Year 1 and $600,000 in Year 2.

Calculating NPV:

NPV = -$1,000,000 + $700,000 / (1 + 0.10)^1 + $600,000 / (1 + 0.10)^2

NPV = -$1,000,000 + $636,363.64 + $495,867.77 = $132,231.41

The project’s internal rate of return (IRR) can be calculated using the cash flows or through financial calculator/software, which yields approximately 15.24%.

Regarding forward exchange rates:

One-year forward rate = spot rate (1 + domestic interest rate) / (1 + foreign interest rate) = 1074 (1 + 0.0375) / (1 + 0.02) ≈ 1074 * 1.0375 / 1.02 ≈ 1092.48 won per USD.

Two-year forward rate = 1074 * (1 + 0.0375)^2 / (1 + 0.02)^2 ≈ 1099. Това

For the project undertaken by a similar U.S.-based firm, profitability remains similar; hence, the NPV and IRR calculations stay consistent, maintaining the project's attractiveness.

Bank Financing

By analyzing the company's accounts payable and current liabilities, the financing needed to eliminate past-due accounts payable involves calculating the difference between current payables and desired accounts payable period.

The accounts payable are 62 days' purchases. Purchases in total amount to approximately $660,000 (derived from annual sales and the payment terms). To bring payables down to 30 days' worth, the company needs to reduce the accounts payable by approximately $330,000.

For interest calculations, at 8% simple interest over one month (30 days):

Interest = Principal rate time = $330,000 0.08 (30/360) ≈ $2,200.

Using an add-on interest loan at 7.4%, repaid over 12 months, the total loan amount can be derived from the monthly installment formula, resulting in a loan of approximately $330,000, with monthly payments around $28,383. The corresponding effective annual percentage rate (APR) can be calculated based on these payments, approximately 8.2%, which reflects the true cost of borrowing.

Cash Budgeting

Koehl’s Doll Shop needs a cash forecast considering upcoming sales, purchases, expenses, and taxes. Starting with cash on hand of $700, the business will plan for expenditures including rent of $2,700, salary payments of $4,800, and a tax payment of $14,000 in December.

In December, total expenses including taxes would be $21,300, and the sales forecast is $150,000 with purchases of $35,000. From these figures, the net cash flow is calculated, adjusting for targeted minimum cash balance of $4,500. The resulting borrowing requirement for December is approximately $9,100, ensuring sufficient liquidity to meet obligations.

If credit sales are assumed in December, the timing of cash collections shifts, increasing the funding gap. As such, the company’s loan requirements could increase to around $12,300 at the end of December when factoring in the credit collection period, highlighting the importance of credit management in cash flow planning.

Cross Rates

The cross rate between yen and peso involves calculating how many yen one can receive per peso using the given exchange rates: 11 pesos per USD and 111.43 yen per USD. The cross rate formula is:

Yen per peso = Yen per USD / Pesos per USD = 111.43 / 11 ≈ 10.13 yen per peso.

This rate indicates the relative strength of the yen against the peso based on the current exchange rates, useful for international trade and currency conversions.

References

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