Question

Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 33?% cash discount for payment within 15 days. The? firm's current average collection period is 60 ?days, sales are 40,000 ?units, selling price is ?$44 per? unit, and variable cost per unit is ?$35. The firm expects that the change in credit terms will result in an increase in sales to 41,000 ?units, that 70?% of the sales will take the? discount, and that the average collection period will fall to 30 days. If the? firm's required rate of return on? equal-risk investments is 225?%, should the proposed discount be? offered????(Note?: Assume a? 365-day year.)

Answer 1

working notes

1.sales = 40000 * 44=1760000 and 41000 *44=1804000

2. variable cost= 40000 * 35= 1400000 and 41000 * 35= 1435000

3. avg investment in receivables = 1400000 * 60/365= 230137 and 1435000 * 30/365= 117945

4. cash discount = 3.3% on 70% of sales (note: cash discount should be 3.3% and not 33%)

= 1760000 *3.3% * 70%= 40656 and 1804000 *3.3% 70%= 41672

4. required rate of return should be 22.5% p.a. and not 225%

particulars	present policy	proposed policy	increas/decrease in benefit/costs
sales	1760000	1804000
less : variable costs	1400000	1435000
contribution/benefit (A)	360000	369000	+ 9000
average investment in receivbables	230137	117945
COSTS
opportunity cost of capital	230137 *22.5%=51781	117945*22.5%=26538
cash discount	40656	41672
total costs	92437	68210	+ 24227

net benefit from the proposed policy = increase in benefits + decrease in costs= 9000 + 24227=33227

So the proposed discount should be offered