1a) Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 d
ID: 2383987 • Letter: 1
Question
1a)
Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days. Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?
1b)
Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?
a. The company would have less common equity than before.
b. The company's net income would increase.
c. The company would have to pay less taxes.
d. The company's interest expense would remain constant.
e. The company's taxable income would fall.
a. The company would have less common equity than before.
b. The company's net income would increase.
c. The company would have to pay less taxes.
d. The company's interest expense would remain constant.
e. The company's taxable income would fall.
Explanation / Answer
1a)
Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days. Your firm is not taking discounts, but is paying after 25 days instead of waiting until Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%. But since your firm is neither taking discounts nor paying on the due date, what is the effective annual percentage cost (not the nominal cost) of its costly trade credit, using a 365-day year?
Effective annual percentage cost = (1+2/(100-2) )^(365/15) - 1
Effective annual percentage cost = 63.49%
1b)
Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?
b. The company's net income would increase.
Note :
a. The company would have more common equity than before
c. The company would have to pay more taxes as interest expenses decreases and net income before tax increases
d. The company's interest expense would decrease as proceed from issue of equity is being paid to bond holder and therefore it would decrease interest expenses
e) The company's taxable income would increase as interest expenses decrease and net income before tax increases
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