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 percent because the discount will make the firm's price competitive.

  

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.)

  

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 percent because the discount will make the firm's price competitive.

Explanation / Answer

Basic workings before answer the question

(1) Accounts receivables ( current) = 216000 * 45 days / 360 days = 27000

Accounts receivables ( with Discount offer ) = 216000 * (1.10) * 15 / 360 = 9900

Decrease in Accounts receivables investment = 27000 - 9900 = 17100

Interest saved = 17100 * 9% = 1539

(2) Increase in sales = 216000 * 10% = 21600

Increase in Income = 21600 * 20% = 4320

(3) Discount Expenses = 216000 * 1.10 * 2/100 = 4752

           Net change in Income Interest saved 1539 Increase in Income 4320 Total 5859 (-) Discount expenses 4752 Net change in income 1107

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