Fancy Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast. Joe Fancy, the president of the company, is thinking about changing the firm’s credit policy to attract customers away from competitors. The present policy calls for 1/10, net 30 cash discount. The new policy would call for a 5/10, net 45 cash discount. Currently, 35 percent of Fancy customers are taking the discount, and it is anticipated that this number would go up to 65 percent with the new discount policy. It is further anticipated that annual sales would increase from a level of $200,000 to $600,000 as a result of the change in the cash discount policy.
The increased sales would also affect the inventory level. The average inventory carried by Logan is based on a determination of an EOQ. Assume sales of fans and heaters increase from 11,500 to 23,750 units. The ordering cost for each order is $175, and the carrying cost per unit is $2.50 (these values will not change with the discount). The average inventory is based on EOQ/2. Each inventory has an average cost of $12.50.
Cost of goods sold is equal to 60 percent of net sales; general and administrative expenses are 15 percent of net sales; and interest payments of 14 percent will only be necessary for the increase in the accounts receivable and inventory balances. Taxes will be 34 percent of before-tax income.
a. Compute the accounts receivable balance before and after the change in the cash discount policy. Use the net sales (total sales minus cash discounts) to determine the average daily sales.
b. Determine the EOQ before and after the change in the cash discount policy. Translate this into average inventory (in units and dollars) before and after the change in the cash discount policy.
c. Compute the following income statement.
d. Should the new cash discount policy be utilized? Briefly comment.