CMA Study Group

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  • 1.  Help Please Part3 Q

    Posted 10-07-2010 03:39 PM

    Q1. Harson Products currently has a conservative credit policy and is in the process of reviewing three other credit policies. The current credit policy (Policy A) results in sales of $12 million per year. Policies B and C involve higher sales, accounts receivable and inventory balances, as well as higher bad debt and collection costs. Policy D grants longer payment terms than Policy C, but charges customers interest if they take advantage of the lengthy payment terms. The policies are outlined below.

                                                                                 P o l i c y (000)

                                                              A                   B                 C                   D

     Sales                                          $12,000         $13,000       $14,000        $14,000

    Average accounts receivable         1,500             2,000           3,500            5,000

    Average inventory                         2,000             2,300           2,500             2,500

    Interest income                               0                     0                  0                  500

    Bad debt expense                         100                 125              300                400

    Collection cost                               100                 125               250                350

    If the direct cost of  products is 80% of sales and the cost of short-term funds is 10%, what is the optimal policy for Harson?

    a. Policy A.

    b. Policy B.

    c. Policy C.

    d. Policy D.

    Q2. Foster Products is reviewing its trade credit policy with respect to the small retailers to which it sells. Four plans have been studied and the results are as follows.

                     Annual             Bad            Collection            Accounts

    Plan          Revenue          Debt           Costs                  Receivable               Inventory

      A            $200,000      $ 1,000         $1,000                 $20,000                   $40,000

      B             250,000          3,000           2,000                  40,000                     50,000

      C             300,000          6,000           5,000                  60,000                     60,000

      D             350,000          12,000         8,000                  80,000                     70,000

    The information shows how various annual expenses such as bad debts and the cost of collections change as sales change. The average balance of accounts receivable and inventory have also been projected. The cost of the product to Foster is 80% of the selling price, after-tax cost of capital is 15%, and Foster’s effective income tax rate is 30%. What is the optimal plan for Foster to implement?

    a. Plan A.

    b. Plan B.

    c. Plan C.

    d. Plan D.



  • 2.  Re: Help Please Part3 Q

    Posted 10-07-2010 11:52 PM

    2. The answer is B

    Plan         GP        Bad Debt & C.C.   Net Income              Net Income after Tax@.3     Oppertunity Cost*      Economic Income

    A           40,000       2,000                      38,000                              26,600                                8,400                    18,200

    B           50,000       5,000                      45,000                              31,500                               12,300                    19,200

    C           60,000      11,000                     49,000                             34,300                                16,200                    18,100

    D           70,000      20,000                     50,000                             35,000                                17,700                    17,300

    *Calculation of Oppertunity Cost ( Cost of Capital blocked in AR & Inventory )     

    Plan               Inventory                   AR                      AR at Cost ( 80% )            Total Amount Blocked          Cost @ 15%

    A                     40,000                    20,000                      16,000                                  56,000                               8,400 



  • 3.  RE: Re: Help Please Part3 Q

    Posted 05-31-2017 11:22 PM
    Your above calculation maybe miss 2 things:
    1/ Account receivable (AR) is your asset and have the cost of capital same as inventory. So, you convert AR to Cost of sale is not right way to compute the opportunity cost.
    2/ All comparision should be made in the same case: before tax or after tax. Your calculation show income after tax plus opportunity cost before tax. So not much resonable.

    I suggesst solution as following
    Plan  EBIT   OPP COST BLOCKED IN CAP  Eco EBIT
    A 38,000         9,000 29,000
    B 45,000       13,500 31,500
    C 49,000       18,000 31,000
    D 50,000       22,500 27,500

    Therefore, plan B is acceptable.

    ------------------------------
    Bao Nguyen Quoc
    Student
    Ho Chi Minh
    Viet Nam
    ------------------------------



  • 4.  RE: Re: Help Please Part3 Q

    Posted 06-12-2023 10:09 AM

    Hi

    Help please..this is the solution as per IMA..why is incremental cost of capital taken



    ------------------------------
    Dhiya David
    Accountant
    Dubai
    United Arab Emirates
    ------------------------------



  • 5.  RE: Re: Help Please Part3 Q

    Posted 06-13-2023 04:29 AM
    Dear,

    I just registered for CMA Part one. Anyone know where i can get reading materials and how i can join a study group. I am from Africa (Kenya).

    Kind Regards,
    Nancy Ondiek





  • 6.  Re: Help Please Part3 Q

    Posted 10-07-2010 11:59 PM

    hehehehe. You're correct Rafeek. I made a mistake on my after tax income. I used the tax rate..waaaaaaaa.Tongue out



  • 7.  Re: Help Please Part3 Q

    Posted 10-08-2010 05:00 PM

    Hi Maribel & Rafeek

    Thank you so much .

    But i have a question plan D opportunity cost is 17700 or 20100. i got 20100 by doin your calculations.



  • 8.  Re: Help Please Part3 Q

    Posted 10-08-2010 05:53 PM

    Hi Sarika,

    You are right. I made a  clerical error. Its 20,100

    Opportunity Cost for Plan D

    AR Balance          - 80,000

    AR at V.C ( .80)   - 64,000

    Inventory            - 70,000

    Total                    - 134,000             

    Opportunity Cost @ 15% on 134,000 = 20,100