Gonzales Company currently uses maximum trade credit by not taking discounts on
ID: 2432014 • Letter: G
Question
Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10, net 38 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on thè notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the expected change in net income?Explanation / Answer
Discount = 2 %
Discount days = 10
Actual days to payment = 38
Net purchases per day = $ 11,760
Days in a year = 365
Annual interest rate = 10 %
Tax rate = 40 %
A/P (without discount) = Net purchases per day x Actual days to payment = $ 11,760 x 38 = $ 446,880
A/P (with discount) = Net purchases per day x Discount days = $ 11,760 x 10 = $ 117,600
Amount needed to finance = $ 446,880 - $ 117,600 = $ 329,280
Interest for financing = Amount needed to finance x interest rate = $ 329,280 x 10 % = $ 32,928
Gross purchases = (Net purchases per day x 365) x (1 – Disc. %)
= ($ 11,760 x 365) / (1 – 0.02) = $ 4,292,400 / 0.98 = $ 4,380,000
Discount loss = Gross purchases x Disc. % = $ 4,380,000 x 0.02 = $ 87,600
Pre-tax savings = Discount loss - Interest for financing = $ 87,600 - $ 32,928 = $ 54,672
After- tax savings = Pre-tax savings x (1 – tax rate) = $ 54,672 x (1 = 0.4)
= $ 54,672 x 0.6 = $ 32,803.20 or $ 32,803
Net income will change by $ 32,803 on implementing the plan.
Hence option “$ 32,803” is correct answer.
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