Question

Dome Metals has credit sales of $396,000 yearly with credit terms of net 45 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/18, 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 10 percent. The new credit terms will increase sales by 15% because the 3% 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.)

What is the net change in income? (The answer is not 811).

Answer 1

New sales	$ 455,400	=396000*1.15
Increase in profit from new sales	$    11,880	=396000*15%*20%
Average accounts receivable balance without the discount	$    49,500	=45*(396000/360)
Average accounts receivable balance with the discount	$    22,770	=18*(455400/360)
Reduction in accounts receivable	$    26,730	=49500-22770
Interest savings	$      2,673	=26730*10%
Cost of discount	$    13,662	=455400*3%
Net gain (loss)	$ 891	=11880+2673-13662