Fancy Distributing
Company of Atlanta sells fans and heaters to retail outlets throughout the
Southeast. Joe Fancy, the president of the company, is thinking about changing
the firm’s credit policy to attract customers away from competitors. The
present policy calls for 3/15, net 30 cash discount. The new policy would call
for a 5/10, net 45 cash discount. Currently, 45 percent of Fancy customers are
taking the discount, and it is anticipated that this number would go up to 65
percent with the new discount policy. It is further anticipated that annual
sales would increase from a level of $150,000 to $575,000 as a result of the
change in the cash discount policy.
The increased sales
would also affect the inventory level. The average inventory carried by Logan
is based on a determination of an EOQ. Assume sales of fans and heaters
increase from 10,500 to 22,750 units. The ordering cost for each order is $175,
and the carrying cost per unit is $2.50 (these values will not change with the
discount). The average inventory is based on EOQ/2. Each inventory has an
average cost of $12.50.
Cost of goods sold is
equal to 60 percent of net sales; general and administrative expenses are 15
percent of net sales; and interest payments of 14 percent will only be
necessary for the increase in the accounts receivable and inventory balances.
Taxes will be 34 percent of before-tax income
a. Compute the
accounts receivable balance before and after the change in the cash discount
policy. Use the net sales (total sales minus cash discounts) to determine the
average daily sales.
b. Determine the EOQ
before and after the change in the cash discount policy. Translate this into
average inventory (in units and dollars) before and after the change in the
cash discount policy.
c. Compute the
following income statement.
d. Should the new
cash discount policy be utilized? Briefly comment.
SOLUTION PREVIEW
a. Compute
the accounts receivable balance before and after the change in the cash
discount policy. Use the net sales (total sales minus cash discounts) to determine
the average daily sales
Accounts receivable =
Average collection period X average daily sales
Before: Average collection period
.45
´ 15 = 6.75
.55
´ 30 = 16.5
23.25 days
