Klein\'s Tools is considering offering a cash discount to speed up the collectio

Question

Klein's Tools is considering offering a cash discount to speed up the collection of accounts receivable. Currently the firm has an average collection period of 61 days, annual sales are 30,000 units, the per-unit price is $43, and the per unit variable cost is $32. A 2% cash discount is being considered. Klein's tools estimates that 75% of its customers will take the 2% discount. If sales are expected to rise to 32,000 units per year and the firm has a 14% required rate of return, what minimum average collection period is required to approve the cash discount plan?

Explanation / Answer

1) Additional profit contribution = 32,000 units - 30,000 units × ($43 $32) = $22,000.00 2) Current turnover of accounts receivable = 365/ Average collection period = 365/61 days 5.98 times Current Average Accounts Receivables = ($32 x 30,000)/5.98 times $160,438.36 3) Let X equal the average investment in accounts receivable after the discount Use the equation below to balance the costs and benefits of introducing the discount policy $0 = Additional profit + cost savings from reduced investment in accounts receivable cost of cash discount $0 = $22000 + (14% x ($160,438.36 - X)) - (2% x 75% x 32000 units x $43) $0 = $22000 + ($22,461.37 - 14% X ) - $20640 14% X = $23,821.37 X = Average Accounts Receivables $170,152.64 4) New average collection period Minimum average collection period = 365 days /(32000 units x $32)/$170,152.64 60.65 Days

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