n an effort to speed up the collection of receivables, Hill Publishing Company i
ID: 2452647 • Letter: N
Question
n an effort to speed up the collection of receivables, Hill Publishing Company is considering increasing the size of its cash discount by changing its credit terms from 1/10, net 30 to 2/10, net 30. Currently, the companys collection period averages 43 days. Under the new credit terms, it is expected to decline to 28 days. Also, the percentage of customers who will take advantage of the cash discount is expected to increase from the current 50 percent to 70 with the new credit terms. Bad-debt losses currently average 4 percent of sales and are not expected to change significantly if Hill changes its credit policy. Annual credit sales are $3.5 million, the variable cost ratio is 60 percent, and the required pretax rate of return (i.e., the opportunity cost) on receivable investment is 14 percent. The company does not expect its inventory level to change as a result of its proposed change in credit terms. Assuming that Hill does decide to increase the size of its cash discounts, determine the following:
A.The earning on the funds released by the change in credit terms
B. The cost of the additional cash discounts taken
C. The net effect on Hills pretax profits
Please explain the steps
Explanation / Answer
Answer:A. The earning on the funds released by the change in credit terms:
Decrease in average receivables balance = Present average balance - New average balance
=Annual sales/365 x Present average collection period - Annual sales/365 x New average collection period
= 3,500,000/365 x 43 -3,500,000/365 x 28 = $143,836
Earnings on the funds released by the decrease in receivables = Decrease in receivables x required pre-tax rate of return
= $143,836 x .14 = $20,137
Answer: b. The cost of the additional cash discounts taken:
Cost of additional cash discounts =New cash discounts - Present cash discounts
= Annual sales x percent taking new discount x New percent discount - Annual sales x percent taking present discount x Present percent discount
= $3,500,000 x .70 x .02 - $3,500,000 x .50 x .01 = $31,500
Answer:C The net effect on Hills pretax profits:
Net change in pre-tax profits = Marginal returns - Marginal costs
= (A) - (B)
= $20,137 - $31,500 = -$11,363
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