Question

Dome Metals has credit sales of $396,000 yearly with credit terms of net 45 days, which is also the average collection period. a. Assume the firm offers a 3 percent discount for payment in 18 days and every customer takes advantage of the discount. Also assume the firm uses the cash generated from its reduced receivables to reduce its bank loans which cost 10 percent. What will the net gain or loss be to the firm if this discount is offered? (Use a 360-day year.) b. Should the firm offer the discount? No Yes

Answer 1

Average accounts receivable without discount = Average collection period X Average daily sales

= 45 X (396000/360)

= $ 49,500

Average accounts receivable with discount = Average collection period X Average daily sales

= 18 X (396000/360)

= $ 19,800

Reduction in accounts receivable = $49,500- $19,800

=$29,700

Reduction in accounts receivable leads to reduction in bank loan

Interest savings = $29,700 X 10% = $2,970

Discount on sales = Sales x Discount rate

= 396,000 X 3% = $11,880

Net gain (loss) to the firm if this discount is offered

= $2970-$11,800

= ($8,910)

No, Firm should not offer the discount.