I\'m interested in the number 4. How would I put my recommendation to the CEO of

Question

I'm interested in the number 4. How would I put my recommendation to the CEO of Eboy Corporation?

C D Analysis of Initiating a Cash Discount for Eboy Corporation 2 4 Increase in units due to discount Selling price @net 30 Variable Cost Per Unit 50.00 4,200.00 2,600.00 $ 80,000 (a.) 6 7 8 Additional Profit Contribution fro 10 Cost of Marginal Investment in A 12 Variable cost per unit Raw Material annual usage Accounts Receivable Sales Days Collection Period AR Turnover 1450 13 15 365 45.625 8.0 Average investment presently (w/c (b) 19 20 21 Variable cost per unit Raw Material annual usage 1500 23Expected AR Turnover due to discou 12.0 24 25 Average investment presently (wit (G) 26 27 Reduction in accounts receivablei (d.) 28 29Opportunity cost of funds 30 Cost Savings from reduced investment in $18,281 (e.) 31 32 12.5% Cash Discount term Percentage of customers to take # 34 Raw Material annual usage (new # 35 Selling price per unit 36 37 38 Net Profit (loss) from initiation of proposed $10,081 (g.) Cost of Cash Discount $88,200 (f.) Eboy Corporation Formular

Explanation / Answer

4. Firms generally offer cash discounts to induce customers to make prompt payments. Companies often liberalize their cash discount policy by increasing the discount percentage or by lengthening the period of discount. Both these actions lead to enhancement of the current sales level. Other positive impacts are decline in average collection period and increase in cost of discount.

In this case Eboy Corporation is witnessing increased sales due to the discount being offered. Management would be interested to know if the discount being offered is having a positive impact on its residual income or not. Only if discounts lead to a positive impact on residual income then it should be offered, otherwise there is no accounting as well as business rationale to offer such discounts if they lead to fall in the residual income or lead to additional costs in the form of loss.

The formula is:

Change in residual income = [increase in sales*(1-ratio of variable cost to sales) – increase in discount cost]*(1-tax rate)*cost of capital*savings in receivables instruments.

In the case of Eboy the discount leads to increased sales (and so generation of additional profits), cost savings in the form of reduced investments in accounts receivables. These two benefits are $80,000 and $18,281 respectively. Total benefits = 80,000+18,281 = $98,281.

Cost of discount = $88,200

As the benefits of offering discount (98,281) is > the associated costs (88,200), the management of Eboy should go ahead with the discount as it is generating incremental accounting profits for the company.

(Total = 250 words)

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