The current balance in accounts receivable for Eboy Corporation is $443,000. This level was achieved with annual (365 days) credit sales of $3,544,000. The firm offers its customers credit terms of net 30. However, in an effort to help its cash flow position and to follow the actions of its rivals, the firm is considering changing its credit terms from net 30 to 2/10 net 30. The objective is to speed up the receivable collections and thereby improve the firm’s cash flows. Eboy would like to increase its accounts receivable turnover to 12.0.

The firm works with a raw material whose current annual usage is 1,450 units. Each finished product requires one unit of this raw material at a variable cost of $2,600 per unit and sells for $4,200 on terms of net 30. It is estimated that 70% of the firm’s customers will take the 2% cash discount and that, with the discount, sales of the finished product will increase by 50 units per year. The firm’s opportunity cost of funds invested in accounts receivable is 12.5%

In analyzing the investment in accounts receivable, use the variable cost of the product sold instead of the sale price, because the variable cost is a better indicator of the firm’s investment.

TO DO

Create a spreadsheet similar to Table 15.3 to analyze whether the firm should initiate the proposed cash discount. What is your advice? Make sure you calculate the following:

  a. Additional profit contribution from sales.

  b. Average investment in accounts receivable at present (without cash discount).

  c. Average investment in accounts receivable with the proposed cash discount.

  d. Reduction in investment in accounts receivable.

  e. Cost savings from reduced investment in accounts receivable.

  f. Cost of the cash discount.

  g. Net profit (loss) from initiation of proposed cash discount.