Problem:
Logan distributing Company of Atlanta sells fans and heater to retail outlets throughout the Southeast. Joe Logan, the president of the company, is thinking about changing the firm's credit policy to attract customer away from competitors. The present policy calls for a 1/10, net 30 cash discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of Logan customers are taking the discount, and it is anticipated the this number would go up to 50% with the new discount policy. It is further anticipated that annual sales would increase from a level of $400,000 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 15,000 to 22,500 units. The ordering cost for each order is $200, and the carrying cost per unit is $1.50 ( these values will not change with the discount). The average inventory is based on EOQ/2. Each unit in inventory has an average cost of $12. Cost of goods sold is equal to 65% of net sales, general and administrative expenses are 15% of net sales, and interest payments of 14% will only be necessary for the increase in the accounts receivable and inventory balances. Taxes will be 40% of before tax-income.
a) Compute the accounts receivables 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 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) Complete the following income statement.
Before Policy Change After Policy Change
Net sales ( sales-
discount)
Cost of Goods sold
Gross profit
General and Administrative Expense
Operating profit
Interest on increase in accounts
receivable and inventory(12%)
Income before taxes
Taxes
Income after taxes
d) Should the new cash discount policy be utilized? Briefly comment.