Read the attached case and answer the following questions:

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

2. If a customer passes on the discount under either proposal, what does this imply about the customer's financial position?

3. Evaluate the two proposals. Should either proposal be accepted, or should the company continue with its present terms?

- Pro Forma (Projected) Income Statement and Balance Sheet data shown in Exhibit 1 are based on projected figures for 2020 if no credit policy change is implemented

1. If neither proposal is attractive, what other actions could Campagnola take to improve on its collections?

2. If any proposal that might reduce Sales were to be implemented, what other costs/problems might be considered?

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 - Pro-Forma Income Statement and Balance Sheet, 2020

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 $52,000 Accounts Payable $83,200

Accounts Receivable 205,150 Notes Payable 156,000

Inventory 156,000 Total Current Liab. 239,200

Total Current 413,150 LTD 208,000

Equity 485,950

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