C. Charles Smith recently was hired as president of Dellvoe Office Equipment Inc., a small manufacturer of metal office equipment. As his assistant, you have been asked to review the company's...

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Answered Same DayDec 25, 2021

Answer To: C. Charles Smith recently was hired as president of Dellvoe Office Equipment Inc., a small...

David answered on Dec 25 2021
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A: Short-term loans are any liability that was originally paid within one year. The four main
sources of short-term loans are: provisions, liabilities, loans from commercial banks and
commercial paper.
B: Accruals increase automatically if a company's business expands. They are composed of
accrued wages and deferred taxes. The provision is "free" in the sense t
hat no explicit interest in
money is paid, which is made up of provisions. A company can not properly control due to the
payment deadlines of economic forces and industries is defined as the date of payment of taxes
are set by law of their limits.
C: Commercial credit is a spontaneous source of finance in the sense that it is the result of
normal business transactions. Commercial credit is the largest category of short-term debt,
accounting for about 40 percent of the current liabilities of the average non-financial company.
This percentage is slightly larger for small enterprises, as they often do not meet the
requirements for funding from other sources and therefore largely depend on commercial
lending.
D1: If Dellvoe’s gross purchases are $50,000 annually, then, with a 2 percent discount,
net purchases are 0.98 ($50,000) = $49,000.
If we assume a 360-day year, then net daily purchases are $49,000/360 = $136.11.
D2: If the discount is taken, then Dellvoe must pay this supplier on Day 11 for purchases made
on Day 1, on Day 12 for purchases made on Day 2, and so on. Thus, in a steady state, Dellvoe
will on average have 10 days’ worth of purchases in payables, so,
Payables = 10($136.11) = $1,361.11.
If the discount is not taken, then Dellvoe will wait 50 days before paying, so
Payables = 50($136.11) = $6,805.56.
Therefore:
Trade credit if discounts are not taken: $6,805.56 = total trade credit
Trade credit if discounts are taken: 1,361.11 = free trade credit
Difference: $5,444.45 = costly trade credit
Here we see that Dellvoe gets $1,361.11 of free credit—it can wait 10 days and still take the
discount. If the firm forgoes the discount then it can get $6,805.56 in credit. The difference,
$6,805.56 ─ $1,361.11 = $5,444.45, is the amount of costly trade credit.
D3: To get $5,444.45 of costly trade credit Dellvoe must give up 0.02 ($50,000) = $1,000 in lost
discounts annually. Because the forgone discounts pay for $5,444.45 of credit, the APR is 18.37
percent:
%4.181837.0
45.444,5$
000,1$
APR 
%37.181837.09020408.0
40
360
98
2
dateDiscount - date Payment
360
% Discount1
% Discount
discountcash a
forgoing of Cost




Note that (1) the formula gives the same cost rate as was calculated earlier, (2) the first term is
the periodic cost of the credit (Dellvoe spends $2 to get the use of $98), and (3) the second term
is the number of ―savings periods‖ per year (Dellvoe delays payment for 50 ─ 10 = 40 days, and
there are 360/40 = 9 40-day periods in a year.)
The effective annual rate is 19.94%:
19.94%. = 0.1994 = 1 -
0.98
0.02
+ 1 = 1
% iscountD - 1
% iscountD
+ 1EAR
9m













E1: With a simple interest loan, Dellvoe gets the full use of the $800,000 for a year, and then
pays 0.09($800,000) = $72,000 in interest at the end of the term, along with the $800,000
principal repayment. For a one-year simple interest loan, the simple rate, 9 percent, is also the
effective annual rate.
Note that if the loan had been for six months at an 8 percent rate, then Dellvoe would have had to
pay (0.08/2)($800,000) = 0.04($800,000) = $32,000 in interest after six months, plus repay the
principal....
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