Viaduct Par, Inc., currently sells on terms 1/10, net 30, with bad debt losses at 1% of gross sales. Of the 99% (by dollar value) of the customers who pay, 50% take the discount and pay on Day 10, while the remaining 50% pay on Day 30.

The firms gross sales are currently $2,000,000 per year with cost of sales at 75% (2/3 of total cost is the variable cost component) of the gross sales amount. The firm finances its receivable with a 10% line of credit.

Viaducts credit manager has proposed that credit terms be changed to 2/10, net 40. He estimates that these terms would boost sales to $2,500,000 per year. However, bad debt losses would double to 2% of the new sales level. The expected increase in sales is projected to lead to an increase capacity requirement thus cutting gross profit margin to just 18%. It is expected that 50% of the paying customers will continue to take the discount and pay on Day 10, while 50% will pay on Day 40. (Note: Use 360 days per year. The average collection period will be the weighted average of the length of days before the customer would pay. Also only consider cost of sales in obtaining investment in A/R leaving out the top-up margin in the computation for the investment cost.)

What is your estimated increase in discounting cost if the company shifts to the proposed credit term? Write amounts fully and not in their short form (e.g. 1,000 and not 1K)