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##### Notes: In the most recent fiscal year, its sales w...

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Notes: In the most recent fiscal year, its sales were \$18 million with \$2,500,000 in aftertax profits. Historically, the firm shipped out its goods with a 30 day pay period allowed, with no cash discount offered. In looking over the numbers, Beth (CEO) felt the customers, on average, were taking over 30 days to pay. The receivables were based on average daily credit sales of \$54,274 throughout the year. Beth told AL (CFO) to consider the impact of a cash discount on the accounts receivable balance of the firm as well as its profitability. AL evaluated the effect of the three alternative cash discount policies shown in Table 2. He ran some pilot studies among customers and determined the results below. 10% of customers would take advantage of the 1% discount by paying within 10 days. If the 2% discount were offered, 25% would take it, and if the 3% discount were offered, 60% of the customers would take advantage of it. It was assumed in each case that those who do not take the discount would pay at the end of 30 days. Table 1. Accounts Receivables Outstanding, December 2006 Days Outstanding Amount 0-10 20,000 10-20 150,000 20-30 400,000 30-40 650,000 40-50 430,000 50-60 350,000 Total A/R 2,000,000 Table 2. New Terms for Cash Discounts Alternative Terms 1 1/10,net 30 2 2/10,net 30 3 3/10,net 30 He then computed the new average collection period(s) based on the data in the prior paragraph. With an assumption of average daily credit sales remaining at \$54,274 per day, he also computed the anticipated new accounts receivable balance based on the three different cash discount policies. He was informed by his corporate treasurer that any freed up funds from accounts receivable could be used elsewhere in the corporation to earn a return of 18%. Required: 1. Compute the current average collection period based on the data in Table 1. In doing this, multiply the midpoint of the days outstanding, by the weight assigned to that category. For example, the midpoint of the second company is 15 days and the category represents 7.5% of total accounts receivable (\$150,000/2,000,000). Its value is 1.125 days (15 days * .075). After this process is followed for all six categories, add up the total to get the average collection period. 2. Compute the new average collection period based on the terms in Table 2 and the results of the pilot study. Use the simplifying assumption that under the new policies all customers will all pay at the end of the 10th day or the end of the 30th day. i.e., for the 1/10, net 30 10% * 10 days= 1 day 90% * 30 days= 27 days 28 days average collection period 3. Assuming average daily credit sales remain at \$54,274 per day, what will be the new accounts receivable balance based on the three new cash discount policies? Accounts receivable= average collection period * average daily credit sales 4. Compute the cost of the cash discount based on the three policies under consideration. Recall the total credit sales were \$18 million. Multiply total credit sales times the percent that use the discount for each new discount policy times the size of the discount. 5. Compute the amount of freed up funds based on the three different cash discount policies based on the following: Old accounts receivable (given in table 1) New accounts receivable (Question 3) Freed up funds

Paper#7217 | Written in 18-Jul-2015

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