Megathuselah, is considering a change in its accounts receivable policy which its marketing executives believe will increase the firm’s sales and thus bottom line. The company has total annual credit sales of $144 million with a gross margin of 28% (no growth). To encourage early payment the firm offers payment terms on accounts receivable of 1/10 net 30 which it finances with its 5% line of credit. Presently, one in ten accounts is settled ten days after the purchase, the rest pay 30 days after purchase. Bad debts expenses total $2.8 million per year and its tax rate is 30%.

1. If credit terms are changed to 1/10 net 40 and the collection pattern in unchanged cash inflows to the firm will be disrupted for the next 10 days as accounts due take advantage of the longer due date. How much borrowing from the line of credit will be required to finance this? hint: begin by calculating daily credit sales
2. If credit terms are changed as in part a) how much additional sales (annually) will be required to offset this cost and keep the NPV (of the decision to extend credit) unchanged? (Assume fixed costs remain the same)
3. If one of their clients currently finances their accounts payable with a 12% line of credit, should they pay Megathuselah on day 10 or day 40?

Answer rating: 100% (QA)

a Working capital Annual total credit sale 144 million Gross margin 28 no growth 110 net 30 current ... View the full answer