DDR Corporation has a 12 percent opportunity cost of funds and currently sells on terms of net/10, EOM. The company has sales of 10 million a year, which are 80 percent on credit and spread evenly over the year. The average collection period is currently 60 days. If DDR Company offered terms of "2/10, n/30," customers representing 60 percent of its credit sales would take the discount Should DDR Company change its terms from “net/10, EOM" to “2/10, net 30"? Why?

DDR Corporation has a 12 percent opportunity cost of funds and currently sells on terms of net/10, EOM. The company has sales of 10 million a year, which are 80 percent on credit and spread evenly over the year. The average collection period is currently 60 days. If DDR Company offered terms of "2/10, n/30," customers representing 60 percent of its credit sales would take the discount Should DDR Company change its terms from “net/10, EOM" to “2/10, net 30"? Why?

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter15: Managing Short-term Assets

Section: Chapter Questions

Problem 13PROB

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Now assume that it is several years later. The brothers are concerned about the firm’s current credit terms of net 30, which means that contractors buying building products from the firm are not offered a discount and are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80% (by dollar volume) of the firm’s paying customers generally pay the full amount on Day 30; the other 20% pay, on average, on Day 40. Of the firm’s gross sales, 2% ends up as bad-debt losses. The brothers are now considering a change in the firm’s credit policy. The change would entail: (1) changing the credit terms to 2/10, net 20, (2) employing stricter credit standards before granting credit, and (3) enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2% discount, but all others would have to pay the full amount after only 20 days. The brothers believe the discount would both attract additional customers and encourage some existing customers to purchase more from the firm—after all, the discount amounts to a price reduction. Of course, these customers would take the discount and hence would pay in only 10 days. The net expected result is for sales to increase to $1,100,000; for 60% of the paying customers to take the discount and pay on the 10th day; for 30% to pay the full amount on Day 20; for 10% to pay late on Day 30; and for bad-debt losses to fall from 2% to 1% of gross sales. The firm’s operating cost ratio will remain unchanged at 75%, and its cost of carrying receivables will remain unchanged at 12%. To begin the analysis, describe the four variables that make up a firm’s credit policy and explain how each of them affects sales and collections.
Dome Metals has credit sales of $288,000 yearly with credit terms of net 120 days, which is also the average collection period. Assume the firm adopts new credit terms of 3/18, net 120 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.) b. Should the firm offer the discount?
Howes Inc. purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15,net 50. If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (Assume a 365-day year.)
Breeze Corp. is planning to change its credit terms from 4/10, n/30 to 5/15, n/35. Currently, 50% of customers take the 4% discount. Under the new term, 5/15, n/35, discount customers are expected to rise to 60%. Under both of the terms, 50% of the customers who do not take the discount are expected to pay on due date, while the remainder will pay 10 days after. What is the increase in days sales outstanding from the old credit term to the proposed credit term? (Use 360 days) a. 25 days b. 2.5 days c. 1.5 days d. 4.25 days