Dome Metals has credit sales of $234,000 yearly with credit terms of net 30 days

Question

Dome Metals has credit sales of $234,000 yearly with credit terms of net 30 days, which is also the average collection period. Assume the firm adopts new credit terms of 2/18, net 30 and all customers pay on the last day of the discount period. Any reduction in accounts recevable will be used to reduce the firm's bank loan which costs 10 percent The new credit terms will increase sales by 10% because he 2% discount will make the firm's pric competitive. a. If Dome eams 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.) Net change in income b. Should the firm offer the discount? Hints References eBook & Resources

Explanation / Answer

new sales = 1.10*234000 = 257400 increase in profit = profit %*increase in sales = 0.25(257400-234000) = 5850 average accounts receivable without the discount = average collection period*average daily sales = 30*(234000/360) = 19500 average accounts receivable with the discount = 18*(257400/360) = 12870 reduction in accounts receivable = 19500-12870 = 6630 the reduction in accounts receivable will be used to reduce the firm's loan balance interest savings = interest rate*loan reduction = 0.10*6630 = 663 cost of discount = 2%*257400 = 5148 net gain = increase in profit+interest savings-cost of discount = 5850+663-5148 = 1365 net change in income = $ 1365 b) yes the firm should offer the discount

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