Title Gitman Chapter 14 2nd Payments Working Capital Inventory Debits And Credits Discounts And Allowances 156.5 KB 9
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cash discount, annual ales will increase 50 units to 1,150 units, and cost of capital
14%. The bad debt will remain at 2.6% of sales. Should the firm offer the cash
discount?

Solution:
1. Additional profit from sales: 50 unit × (3,000 – 524 – 1,381) = \$54,750
2. Average investment in A/R (present terms)
= [(3,000 x 1,100) / 365] × 40 = \$361,644
average investment in A/R (proposed terms)
= [(3,000 x 1,150) / 365] × 22 = \$207,945
reduction in A/R investment = 361,644 – 207,945 = \$153,699
cost saving in A/R investment = 153,699 × 14% = \$21,518
3. Cost of cash discount = -2% × 80% × (1,150 × 3,000) = -\$55,200
current bad debt = \$(1,100 × 3,000 × 2.6%) = \$85,800
new bad debt = \$(1,150 × 3,000 × 20% × 2.6%) = \$17,940
reduction = \$85,800 - \$17,940 = \$67,860

5. Net cost from initiation of cash discount = \$54,750 + 21,580 + 67,860 – 55,200
= \$88,990
 Should initiate the cash discount

c. Credit monitoring
 Ongoing review of a firm’s accounts receivable to determine whether customers are

paying according to stated credit terms

1. Techniques for credit monitoring
a) Average collection period = accounts receivable / average credit sales per day

b) Aging of A/R
: uses a schedule that indicates the percentages of the total A/R balance that have

been outstanding for specified periods of time
Ex: p.704:

2. Collection techniques (Table 14.5, p.803)
a) letters b) telephone calls c) personal visits
d) collection agencies e) legal action

E. Managing receipts and disbursements
 Goals: a) speed up collections; b) slow down payments; and c) maximize the return

of S-T investments

Days A/R (\$) % of total
Current \$60,000 30

0-30 \$40,000 20
31-60 \$66,000 33
61-90 \$26,000 13

Over 90 \$8,000 4
Total \$2,000000 100%

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Overdue accounts
required attention