Question

Suppose that ABC Inc. (see Practice Problem 30) switches to 3/10 net 30 from net 30. It is estimated that 80 percent of customers will take advantage of the discount, while the remaining 20 percent will pay on day 30. The price will increase from $52 to $53 per unit; unit sales will remain at 11,000 per year; and variable costs will remain at $25 per unit. Bad debt losses will not be affected. Assume a 40 percent tax rate and a 5 percent discount rate. Should the firm switch to the new policy?

Answer 1

Please see the table below. All financials are in $. Please see the second column titled "Linkage"  to understand the mathematics. The last row shows the incremental profit under new policy which is positive. Hence, the firm should switch to the new policy

	Linkage	New Policy	Old Policy
Nature		3/10 net 30	Net 30
Customers opting discount	A	80%	0%
Customers paying on day 30	B = 1 - A	20%	100%
Sale price	C	53	52
Sale volume	D	11,000	11,000
Variable cost	E	25	25
Tax rate	F	40%	40%
Discount rate	G	5%	5%
Credit sales	H = C x D x B	116,600	572,000
[+] Cash sales	I = C x D X A	466,400	-
[-] Discount	J = I x 3%	13,992	-
Net sales	K = H + I - J	569,008	572,000
Variable cost	L = D x E	275,000	275,000
Reduction in receivable	M = 572,000-116,600	455,400
Interest savings dues to reduction in receivables	N = M xG	22,770
Incremental profit before taxes	O = K - L + N	316,778	297,000
[-] Taxes	P = F x O	126,711	118,800
Net profit after taxes	O - P	190,067	178,200
Increase in profit	'=190,067 - 178,200 =	11,867