Dome Metals has credit sales of $252,000 yearly with credit terms of net 60 days
ID: 2744149 • Letter: D
Question
Dome Metals has credit sales of $252,000 yearly with credit terms of net 60 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/10, 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 11 percent. The new credit terms will increase sales by 20 percent because the discount will make the firm's price competitive.
If Dome earns 25 percent on sales before discounts, what will be the net change in income if the new credit terms are adopted? (Use a 360-day year.)
Dome Metals has credit sales of $252,000 yearly with credit terms of net 60 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/10, 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 11 percent. The new credit terms will increase sales by 20 percent because the discount will make the firm's price competitive.
Explanation / Answer
a. New sales = 1.20*252000 = $302,400
Increase in profit = Profit percentage * Increase in sales
Increase in profit = 0.25*(252,000-302,400) = $12,600
Average Accounts receivable balance without discount = Avg. collection period * avg daily sales = 60* 252,000/360 = 42,000
Average Accounts receivable balance with the discount = Avg. collection period * avg daily sales = 10* 302,400/360 = 8,400
Reduction in accounts receivable = 42000 -8400 = $33,600
Interest savings = Bank interest * Reduction in accounts receivable = 0.11*33,600 = $3,696
Cost of discount = discount rate * Sales = 0.03 * 302,400 = $9,072
Net Gain = increase in profit + Interest savings - Cost of discount
Net gain = 12,600 +3,696 -9,072 = $7,224
Net chnage in income = $7,224
b. Yes, if the firm offers 3% discount, it will realize a gain of $7,224
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