Gardner Company currently makes all sales on credit and offers no cash discount.
ID: 2633902 • Letter: G
Question
Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The firm's current average collection period is 60 days, sales are 40,000 units, selling price is $45 per unit, and variable cost per unit is $36. The firm expects that the change in credit terms will result in an increase in sales to 42,000 units, that 70% of the sales will take the discount, and that the average collection period will fall to 30 days. If the firms required rate of return on equalrisk investments is 25%, should the proposed discount be offered? (Note: Assume a 365-day year.)
Explanation / Answer
The new sales is 42,000.
Discount on 70% of sales = 70% (42,000) = 29,400
Annual sales = 29,400 X $45 = $1,323,000
If 2% discount is offered, the total amount payable on sales is
Amount to be paid after discount = 0.98 ($1,323,000) = $1,296,540
Average sales per day = $1,296,540 / 365
= $3,552
Yes, the proposed discount should be offered because the average collection period has decreased by half and the required return is 25%.
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