Dome Metals has credit sales of $180,000 yearly with credit terms of net 60 days
ID: 2383871 • Letter: D
Question
Dome Metals has credit sales of $180,000 yearly with credit terms of net 60 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/18, net 60 and all customers pay on the last day of the discount period. Any reduction in accounts receivable will be used to reduce the firm's bank loan which costs 12 percent. The new credit terms will increase sales by 15 percent because the discount will make the firm's price competitive.
If Dome earns 20 percent on sales before discounts, what will be the net change in income if the new credit terms are adopted?
Dome Metals has credit sales of $180,000 yearly with credit terms of net 60 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/18, net 60 and all customers pay on the last day of the discount period. Any reduction in accounts receivable will be used to reduce the firm's bank loan which costs 12 percent. The new credit terms will increase sales by 15 percent because the discount will make the firm's price competitive.
Explanation / Answer
Increase in profit from new sales =
Profit percent × Increase in sales = .20 × ($376,200 – 342,000) = $6,840
Average accounts receivable balance without the discount
= Average collection period × Average daily sales = 45 × ($342,000 / 360) = $42,750
Average accounts receivable balance with the discount
= Average collection period × Average daily sales = 18 × ( $342000 / 360) =
Reduction in accounts receivable = $42,750 – 18,810 = $23,940
The $23,940 cash inflow from reducing accounts receivable will be used to reduce the firm's loan balance.
Interest savings = Interest rate × Loan reduction = .10 × $23,940 = $2,394
Cost of discount = Discount rate × Sales = .02 × $376,200 = $7,524
Net gain (loss) = Increase in profit + Interest savings – Cost of discount
= $6,840 + 2,394 – 7,524 = $1,548
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.