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Chapter 3: 1CP_d (page 225)

Logan Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast. Joe Logan, 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 a 1/10, net 30 cash discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of Logan customers are taking the discount, and it is anticipated that this number would go up to 50 percent with the new discount policy. It is further anticipated that annual sales would increase from a level of \(400,000 to \)600,000 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 15,000 to 22,500 units. The ordering cost for each order is \(200, and the carrying cost per unit is \)1.50 (these values will not change with the discount). The average inventory is based on EOQ/2. Each unit in inventory has an average cost of $12. Cost of goods sold is equal to 65 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 40 percent of before-tax income.

d. Should the new cash discount policy be utilized? Briefly comment.

Short Answer

Expert verified

The company should implement the new cash discount policy.

Step by step solution

01

Meaning of cash discount

The cash discount refers to the discount provided by the seller to the buyer when the buyer pays the credit to the seller before the determined date. This discount is a reward for the buyer.

02

Explanation of requirement

The company’s income after taxes will increase if they apply the new cash discount policy from $47,856 to $68,790, so the company should apply this new policy. The sales of the company will also increase if this new policy is implemented.

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Most popular questions from this chapter

Eastern Auto Parts Inc. has 15 percent of its sales paid for in cash and 85 percent on credit. All credit accounts are collected in the following month. Assume the following sales:

January

\(65,000

February

\)55,000

March

\(100,000

April

\)45,000

Sales in December of the prior year were $75,000. Prepare a cash receipts schedule for January through April.

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be \)240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

Nowlin Pipe & Steel has projected sales of 72,000 pipes this year, an ordering cost of \(6 per order, and carrying costs of \)2.40 per pipe.

a. What is the economic ordering quantity?

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide \(180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur \)16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket and has a receivables turnover of four times. No other asset build-up will be required to service the new customers. The firm has a 10 percent desired return.

a. Calculate the incremental income after taxes and the return on incremental investment. Should Fast Turnstiles Co. extend credit to these customers?

Route Canal Shipping Company has the following schedule for aging of accounts receivable:

b. If the firm had $1,500,000 in credit sales over the four-month period, compute the average collection period. Average daily sales should be based on a 120-day period.
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