Question

A company with annual sales of $22,000,000 is considering changing its payment terms from net 40 to net 30 to encourage customers to pay more promptly. The company forecasts that customers would respond by paying on day 32 rather than day 44 as at present (assume a 360 day year) but would decrease their purchases by $400,000 per year. The company also forecasts that its idle cash balance would decrease by $80,000 and administrative costs would be reduced by $30,000 per year. The company's variable costs average 62% of sales, it is in the 35% marginal tax bracket, and it has an 8% cost of capital.

Part A: Calculate the incremental cash flows from accepting this proposal, and organize your cash flows from part A into a cash flow spreadsheet.

Part B: Calculate the proposal's NPV, IRR, and NAB.

Part C: Should the company shorten its payment terms?

Answer 1

Working capital changes:
Decrease in Receivables   -----------------1	720000
(22000000-400000)/360*(44-32)=
Decrease in cash balance------------------2	-80000
Operating cash flows:
Decrease in sales	-400000
Less:Savings in Variable costs(-62%*400000)	248000
Less: Savings in admn.costs	30000
Net decrease	-122000
Less Savings in tax at 35%	42700
Incremental EAT------------------------------3	-79300
Net Incremental cash flow --------1+2+3	560700