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Dome Metals has credit sales of $522,000 yearly with credit terms of net 30 days, which is also the average collection period
Dome Metals has credit sales of $522,000 yearly with credit terms of net 30 days, which is also the average collection period. Assume the firm adopts new credit terms of 2/10, net 30 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 8 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 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
r
b. Should the firm offer the discount?
0 Yes 0 No
Expert Solution
a) Computation of Net Change in Income:
New Sales = 522,000 * (1+10%) = 574,200
Increase in profit from new sales = Profit percent *Increase in sales = 0.25 * 52,200 = 13,050
Average accounts receivable balance without the discount = Average collection period * Average daily sales
= 30 * 522,000/360
= 43,500
Average accounts receivable balance with the discount = Average collection period *Average daily sales
= 10 * 574,200/360
= 15,950
Reduction in Accounts Receivables = 43,500 - 15,950 = 27,550
Interest savings = Interest rate * Loan reduction
= 0.08 * 27,550
= 2,204
Cost of discount= Discount rate * Sales
= 0.02 * 574,200
= 11,484
Net gain (loss)= Increase in profit + Interest savings - Cost of discount
= 13,050 + 2,204 - 11,484
= 3,770
b) Yes, the firm should accept the offer.
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