Blueroot Inc. is considering a change in its financing policy. Currently, it use

Question

Blueroot Inc. is considering a change in its financing policy. Currently, it uses maximum trade credit by not taking discounts on its purchases. The standard industry credit terms offered by all its suppliers are 2/10 net 30 days, and the firm pays on time. The new CFO is considering borrowing from its bank, using short-term notes payable, and then taking discounts. The firm wants to determine the effect of this policy change on its net income. Its net purchases are $11,760 per day, using a 365-day year. The interest rate on the notes payable is 10%, and the tax rate is 40%. If the firm implements the plan, what is the expected change in net income?

Explanation / Answer

First of all we need to calculate A/P ..

which ll be as follows

A/P (No discount) = $11,760 * 30 days = $352,800.

A/P(Discount) = $11,760 * 10 days = $117,600

Hence the firm ll need to borrow = $(352800-117600) = $235200

Extra interest = $23250*0.1 = $ 23520

NOw

Total purchases = 365 days * 12,000 gross purchases = $4,380,000.

Discounts = $4,380,000 * 0.02 = $87,600

hence

Pre-tax savings = $87,600

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