TABLE 15.3 Analysis of Initiating a Cash Discount for MAX Company

Additional profit contribution from sales
[50 units ($3,000 $2,300)]		$35,000
Cost of marginal investment in A/Ra
Average investment presently (without discount):
	$278,022
Average investment with proposed cash discount:b
	181,164
Reduction in accounts receivable investment	$ 96,858
Cost savings from reduced investment in accounts receivable (0.14 $96,858)c		13,560
Cost of cash discount (0.02 0.80 1,150 $3,000)		( 55,200)
Net profit from initiation of proposed cash discount		($ 6,640)

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 firms 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 firms 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 firms 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 firms 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 that 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.