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

Initial Cash Flows
Yearly sales		22000000	$
Account Receivables		=	(Sales/360)Xdays Receivables outstanding
		=	(22000000/360)X44
		=	2688889
Cash Sales		Yearly sales - Account Receivables
		19311111.11	$
Variable Cost		62% x sales
		13640000	$
Tax		(Sales- Cost)X Tax Rate
		(22000000-13640000)X35%
		2926000	$
Total Cash Flow		=	Cash sales - Variable Cost - Tax
		=	2745111	$
Cash Flows after changing payment terms
Yearly sales		22000000-400000	$
	=	21600000	$
Account Receivables		=	(Sales/360)Xdays Receivables outstanding
		=	(21600000/360)X32
		=	1920000	$
Cash Sales		Yearly sales - Account Receivables
		19680000	$
Variable Cost		62% x sales
		13392000	$
Tax		(Sales- Cost)X Tax Rate
		(21600000-13392000)X35%
		2872800	$
Total Cash Flow		=	Cash sales - Variable Cost - Tax
		=	3415200	$
Incremental Cash Flow			2695200-3415200		$
			670088.9	$
Answer	670089	USD