The current balance in accounts receivable for Eboy Corporation is $443,000. Thi

Question

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 firm's 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 1 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 firm's 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 firm's 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 firm's investment.
Instructions
Create a spreadsheet similar to Table 14.3 to analyze whether the firm should initiate the proposed cash discount. What is your advice? Make sure 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.

Template to use:

Analysis of Initiationg a Cash Discount       for Eboy Corporation Increase in units due to discount Selling price @net 30 Variable Cost Per Unit Additional Profit Contribution from Sales: $ Cost of Marginal Investment in Accounts Receivable $ Variable cost per unit Raw material annual usage Accounts Receivable Sales Days Collection Period AR Turnover Average investment presently w/o discounts Variable Cost per unit $ Raw material annual usage 0 Expected AR Turnover due to discount Average investment presently with cash discounts Reduction in accounts receivable investment Oppurtunity cost of funds Cost Savings from reduced investment in AR Cash Discount term Percentage of customers to take discount Raw Material annual usage (new) 0 Selling price per unit $ Cost of Cash Discount $ Net Profit from initiation of proposed cash discount

Explanation / Answer

Annual Credit Sales 3544000 Accounts receivables 443000 Credit terms net 30 Accounts receivable turnover = credit sales / accounts receivables 8 New Credit terms 2/10 net 30 Expected AR turnover ratio 12 raw material current usage 1450 units usage of raw material in finished product 1 Variable cost per unit 2600 sale price 4200 Expected number of customers taking discount 70% Expected increase in sales 50 units per annum Opportunity cost of funds invested in AR 12.50% Increase in Units due to discount 50 Sale price at net 30 4200 Variable cost per unit 2600 Additional Profit contribution from sales 80000 Cost of Marginal Investment in Accounts Receivables 309863.01 = (variable cost *rawmaterial usage)/30 Variable cost per unit 2600 Raw Material annual usage 1450 Accounts Receivables 443000 = sales / AR turnover Sales 3544000 Days Collection Period 30 A/R Turnover 8 Average investment present in AR without discounts 133137 = AR - cost of marginal investment Variable cost per unit 2600 Raw material annual usage 1500 Expected AR turnover due to discount 12 Average investment with discounts 325000 = variable cost * raw material annual usage /AR turnover Reduction in Accounts receivable investment 191863 = average investment with discounts - average investment without discounts Opportunity Cost of funds 12.50% Cost savings from reduced investment in AR 23982.88 = reduction in AR * opportunity cost Cash discount term 2/10 Percentage of customers taking discount 70% Raw material annual usage (new) 1500 Selling Price per unit 4200 Cost of cash discount 0.0102041 45000 =raw material annual usage * selling price * % of customers using discount*cost of cash discount Net Profit from initiation of cash discount 58982.88 (Additional profit contribution +cost savings - cost of cash discount) cost of cash discount = discount%/((1-discount%)*(360/(full payment days-discount days))

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