1.Under each of the two alternative proposals, what is the effective cost of foregoing the available discount.If potential credit customers can borrow from local banks at 7% or less, should they pass up the opportunity to take the discount?

Campagnola products, a wholesaler of ethnic food products, has seen a steady increase in its Average Collection Period (ACP), and an increase in bad debt losses over the past couple of years. Management has decided to address this problem by considering a change in its credit terms that are expected to improve collection times and also reduce bad debt losses.

Currently, Campagnola provides trade credit on terms of n/60.While the majority of customers pay (on average) in the allowed 60 days, about 40% of customers are paying 10 days late.Bad debt losses, which once averaged about 1%, have risen to 2% on average.

A management consultant, hired by Campagnola, has recommended two possible changes to the credit terms.

Proposal A:Offer a discount of 1% for early payment in 10 days (Terms of 1/10, n/60) Proposal B:Offer the discount, but reduce the net payment time (Terms of 1/10, n30)

If Proposal B is accepted, it is assumed that Sales will decrease by 8% relative to what is expected under the existing policy; changes in Inventory are assumed to be proportional to changes in Sales.If Proposal A is accepted, no reduction in Sales is expected.Under either proposal, bad debt losses are expected to go back down from 2% to the 1% seen in earlier years.If either proposal is accepted, it is expected that

50% of all customers will take the discount and pay in 10 days.Among those who do not take the discount, it is assumed that 60% will pay on time and 40% will pay 10 days late.

Campagnola has a Cost of Capital of 11.2%

Exhibit 1 - ProForma Income Statement and Balance Sheet, 2018

Income Statement

Sales$1,170,000

COGS$760,500

Gross Profit$409,500

Fixed Expenses$187,200

EBIT$222,300

Interest Expense$33,800

EBT$188,500

Income Tax$75,400

Net Income$113,100

Balance Sheet

Cash$52,000Accounts Payable$83,200

Accounts Receivable205,150Notes Payable156,000

Inventory156,000Total Current Liab.239,200

Total Current413,150LTD208,000

Equity485,950

Total Assets$933,150Total L&E933,150

1.Under each of the two alternative proposals, what is the effective cost of foregoing the available discount.If potential credit customers can borrow from local banks at 7% or less, should they pass up the opportunity to take the discount?