HGR Co (June 09)

Overdraft 3,800
The finance director has completed a review of accounts receivable management and has
proposed staff training and operating procedure improvements, which he believes will
reduce accounts receivable days to the average sector value of 53 days. This reduction
would take six months to achieve from the current date, with an equal reduction in each
month. He has also proposed changes to inventory management methods, which he hopes
will reduce inventory days by two days per month each month over a three-month period
from the current date. He does not expect any change in the current level of accounts
payable.
HGR Co has an overdraft limit of $4,000,000. Overdraft interest is payable at an annual rate
of 6.17% per year, with payments being made each month based on the opening balance at
the start of that month. Credit sales for the year to the current date were $49,275,000 and
cost of sales was $37,230,000. These levels of credit sales and cost of sales are expected to
be maintained in the coming year. Assume that there are 365 working days in each year.

I couldn’t understand the Overdraft calculation:

Overdraft interest calculations
Monthly overdraft interest rate = (1.0617)1/12 = 1.005 or 0.5%
If no action is taken:
Period 1 interest = 3,800,000 × 0.005 = $19,000
Period 2 interest = 3,549,000 × 0.005 = $17,745 or $18,000
Period 3 interest = 3,517,000 × 0.005 = $17,585 or $18,000
If action is taken:
Period 1 interest = 3,800,000 × 0.005 = $19,000
Period 2 interest = 3,075,000 × 0.005 = $15,375 or $15,000
Period 3 interest = 2,566,000 × 0.005 = $12,830 or $13,000

Thank you