Logan Distributing Company of Lethbridge sells fans and heaters throughout the west. Joe Logan, the president of the company, is thinking about changing the credit policies offered by the firm to attract customers away from competitors.
The current policy calls for a 1/10, net 30, and the new policy would call for a 3/10, net 50. 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 carried by Logan. The average inventory carried by Logan is based on a determination of an EOQ. Assume unit sales of fans and heaters will 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). Each unit in inventory has an average cost of $12.00.
Cost of goods sold is equal to 65 percent of net sales, general and administrative expenses are equal to 15 percent of net sales, and interest payments of 14 percent will be necessary only for the increase in the accounts receivable and inventory balances. Taxes will equal40 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- Cash discounts) to determine the average daily sales and the accounts receivable balances.
b. Determine 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. Complete an income statement before and after the policy change.
d. Should the new cash discount policy be utilized? Briefly comment.