Demo Metals has credit sales of $396.000 yearly with credit terms of net 45 days

Question

Demo Metals has credit sales of $396.000 yearly with credit terms of net 45 days. which is also the average collection period. Assume the firm adopts new credit terms of 3/18. Net 45 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 10 percent. The new credit terms will increase sales by 15 percent because the discount will make the firm's price competitive. If Domo earns 20 percent on sales before discounts. what will be the net change in income if the new credit terms are adopted? Should the firm offer the discount? Yes No

Explanation / Answer

a calculation of change in net income increase in sales due to change in credit terms 396000 * 15 % increase in sales due to change in credit terms $59,400 increase in profit because of increase in sale before discount 59400 * 20 % increase in profit because of increase in sale before discount $11,880 discount allowed in new credit terms total sales old sales + increase in sales total sales 396000 + 59400 total sales $455,400 discount allowed in new credit terms 455400 * 3 % discount allowed in new credit terms $13,662 average receivables during the year before change in credit policy 396000 * 45 / 360 average receivables during the year before change in credit policy $49,500 average receivables during the year after change in credit policy 455400 * 18 / 360 average receivables during the year after change in credit policy $22,770 interest amount saved on decrease in average receivable (49500 - 22770) * 10 % interest amount saved on decrease in average receivable $2,673 change in net income increase in profit because change in credit terms $11,880 less : cash discount allowed $13,662 add : saving of interest on bank loan $2,673 net income $891 change in net income $891 b since the net income is increasing because of change in credit terms , the firm should offer the discount

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