Webb Inc. currently makes all sales on credit and offers no cash discounts. The firm is considering offering a 2% cash discount for payments within 10 days. The firm’s current average collection period is 65 days, sales are 400,000 units, selling price is $50 per unit, and variable cost per unit is $40. The firm expects that the changes in credit terms will result in an increase in sales to 410,000 units, that 75% of the sales will take the discount, and that the average collection period will fall to 45 days. Bad debts are expected to drop from 1.0 to 0.9% of sales. If Webb’s required rate of return on investments of similar risk is 25%, should the firm offer the proposed discount? Assume a 365-day year.
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