Ruby Bhd
Subject:FinancePrice:2.86 Bought5
Ruby Bhd., is being offered the terms of sale of “1/7, net 21” by a supplier.
(a) What is the EAR of the cost to Ruby Bhd., if the offered credit is taken up?
(b) If Ruby Bhd., can borrow short-term funds from a bank at the EAR interest rate of 9%, what should Ruby Bhd., do? Explain briefly.
Ruby Bhd., currently sells 14,600 units of product per year using a cash-only sales policy. The cost per unit is RM16 while the price per unit is RM25. Ruby Bhd., is considering switching to a net 21-day credit policy. With this credit policy, Ruby Bhd., estimates that it can sell 14,965 units per year, at the price of RM24 per unit and cost of RM14 per unit. Ruby Bhd.’s required return (EAR) on receivables is 8%.
(c) What is the NPV of Ruby Bhd., switching from the cash-only policy to the credit policy?
(d) Should Ruby Bhd., switch to the credit policy from the cash policy? Why? Explain briefly.
A potential customer applies to Ruby Bhd., to purchase on credit. Ruby Bhd., estimates the probability of the customer paying for the purchase on time after the 21-day credit is 55%. Note that the price and cost per unit of product are, respectively, RM24 and RM14, and the required return (EAR) on receivables is 8%.
(e) Should Ruby Bhd., sell to the customer on credit if the customer is a one-time customer? Justify your decision.
(f) If a customer is a likely repeat customer, what is the maximum probability of customer default that could lead Ruby Bhd., to sell on credit to the customer? Justify your decision.
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
You have asked multiple questions in the same post. As if it was not enough, each of the questions have multiple sub parts. I have therefore addressed all the sub parts of the first question. Please post the balance question, separately. Please don't down vote just because I have answered only one question.
---------------
First Question:
The terms of sale of “1/7, net 21” means 1% discount if paid within 7 days otherwise full payment within 21 days.
Part (a)
Discount, D = 1%; Due date, DD = 21 days; Discount period = DP = 7 days
Hence, Annual rate = D / (1 - D) x 360 / (DD - DP) = 1% / (1 - 1%) x 360 / (21 - 7) = 25.97%
Part (b)
Since the rate of interest on short term funds is lower than the annual rate of discount, Ruby Bhd. should borrow short-term funds from the bank and take the discount offered by the supplier.
