Question

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
b. Should the firm offer the discount?
Yes
NO

Answer 1

a. $3,770 increase in net income

b. Yes, the firm should offer the discount because it will increase net income by increasing total sales and decreasing interest expenses.

Step-by-step explanation:

the impact of new sales policy:

• total credit sales increase by 10% to $574,200
• net earnings before discount is made = $574,200 x 25% = $143,550
• net earnings after discount = $143,550 - ($574,200 x 2%) = $132,066
• Sales discounts is a contra revenue account since it decreases total revenue.

the net earnings before the new sales policy is carried out = $522,000 x 25% = $130,500

the change in net income due to higher sales = $132,066 - $130,500 = $1,566

also, this new policy should decrease average accounts receivable which will also decrease interest expenses:

average accounts receivable before new policy = (30 days x $522,000/360 days) = $43,500

average accounts receivable after new policy = (10 days x $574,200/360 days) = $15,950

the reduction in average accounts receivable = $27,550, which means that the company will spend $27,550 x 8% = $2,204 less on interest payments

total change in net income = $1,566 + $2,204 = $3,770