Dome Metals has credit sales of $216,000 yearly with credit terms of net 45 days

Question

Dome Metals has credit sales of $216,000 yearly with credit terms of net 45 days, which is also the average collection period. Assume the firm adopts new credit terms of 2/15, 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 9 percent. The new credit terms will increase sales by 10% because the 2% discount will make the firm's price competitive. a. If Dome earns 20 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

Explanation / Answer

aNSWER IS =1107

New sales =216000*1.10=237600

increase in profit from new sales = Profit percent × Increase in sales

.20*(237600-216000)

=4320

Average accounts receivable balance without the discount = Average collection period × Average daily sales

= 45 × ($216,000 / 360)

=27000

Average accounts receivable balance with the discount

= Average collection period × Average daily sales

= 15 × ( 237600/ 360) = $9900

=Reduction in accounts receivable = $27000 – 9900=17100

Interest savings = Interest rate × Loan reduction

=9%*17100

=1539

Cost of discount = Discount rate × Sales

2%*237600

=4752

Net gain (loss) = Increase in profit + Interest savings – Cost of discount

=4320+1539-4752

=1107

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