Dome Metals has credit sales of $522,000 yearly with credit terms of net 30 days, which is also the average collection period. Assume the firm adopts new credit terms of 2/10, net 30 and all customers pay on the last day of the discount period. Any reduction in accounts receivable will be used to reduce the firm's bank loan which costs 8 percent. The new credit terms will increase sales by 10% because the 2% discount will make the firm's price competitive. a. If Dome earns 25 percent on sales before discounts, what will be the net change in income if the new credit terms are adopted? (Use a 360-day year.)

The net change in income if the new credit terms are adopted would be of $ 3,770

Explanation:

In order to calculate the net change in income if the new credit terms are adopted we would have to make first the following calculations:

New sales after new credit terms = ($522,000*110%)    

New sales after new credit terms = $ 574,200  

Increase in profit from newsales = (Profit % * New sales)    

Increase in profit from newsales = (25%*($574,200-$522.000))    

Increase in profit from newsales = $ 13,050    

Average accounts receivable balance without discount = (Average collection period*Average daily sales)

Average accounts receivable balance without discount = (30*($522,000/360))  

Average accounts receivable balance without discount = $ 43,500  

Average accounts receivable balance with discount = (Due in days with discount*Average daily sales)

Average accounts receivable balance with discount = (10*($574,200/360))   Average accounts receivable balance with discount = $ 15,950/.    

Reduction in accounts Receivable = ($43,500-$15,950)    

Reduction in accounts Receivable = $ 27,550    

Interest savings is = (Reduction in accounts receivable*firm's bank loan cost)  

Interest savings is = ($27,550*8%)    

Interest savings is = $ 2,204    

Cost of discount = (Discount rate * Sales) = (2%*$574.200) = $ 11,484/.  

Therefore, Net Gain/(Loss) is = (Increase in Profit+Interest savings-Cost of discount)  

Net Gain/(Loss) is = ($13,050+$2,204-$11,484)    

Net Gain/(Loss) is = $ 3,770

The net change in income if the new credit terms are adopted would be of $ 3,770

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