Question

Blueroot Inc. is considering a change in its financing policy. Currently, it uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10 net 30 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on the notes payable is 10%, and the tax rate is 25%. If the firm implements the plan, what is the expected change in net income?

A) 41,202

B) 50,463

C) 45,657

D) 48,060

E) 43,370

Answer 1

Answer : Correct Option is (D.) 48060

Calculations ;

Calculation of Account Payable (No discount) = Purchases per day * Discount days

= 11760 * 30

= 352800

Calculation of Account Payable (With discount) = Purchases per day * Discount days

= 11760 * 10

= 117600

Finace Amount = Calculation of Account Payable (No discount) - Calculation of Account Payable (With discount)

= 352800 - 117600

= 235200

Interest Amount = 235200 * 10% = 23520

Discount Lost on Purchase = [(11760 * 365) / (1 - 0.02)] * 2%

= 4380000 * 2%

= 87600

Pre Tax Saving = 87600 - 23520 = 64080

After Tax Saving = 64080 * (1 - Tax Rate)

= 64080 * (1 - 0.25)

= 48060

If the firm implements the plan, Expected change in net income is 48060