The newly appointed financial manager at Epic Ltd found that the company was using the EOQ model which minimizes the total cost of placing orders. She also discovered that the company has not been taking advantage of quantity discounts offered by suppliers due to strict adherence to the EOQ framework. She was not happy with this arrangement and she approached the board of directors who asked her to provide the necessary quantitative motivation for purchases in greater volumes that are accompanied by quantity discounts. She agreed to do this and also added that the company could consequently consider increasing the discount offered to debtors who settle their accounts within 10 days. The financial manager obtained the following information from which she expects to provide her findings to the board: The company sells only one product for which there is an annual demand of 96 000 units. The purchase price of the product is R60 per unit and the cost of placing an order is R120. The annual holding cost per unit is estimated at 20% of the unit cost price. The current supplier of the product offers a quantity discount of 4% for a purchase of between 1 501 and 4 000 units. The discount increases to 5% for quantities of between 4 001 and 12 000 units. A discount of 6% is offered for the purchase of quantities of 12 001 units or more. The credit terms of Epic Ltd to its customers are currently 2/10 net 30. The selling price of the product is R100 per unit and the only variable costs are the costs of purchasing the product. The financial manager wants to change the credit terms to 3/10 net 30. As a result of the change in credit terms, the following changes are expected: The debtors collection period will decrease from 42 days to 28 days. The credit sales will increase from 22 000 units to 26 400 units. The bad debts will decrease from 3% of sales to 2% of sales. Lastly, the percentage of the credit sales to which the discount will apply will increase from 70% to 80%. Answer ALL the questions in this section.

Question:

Would the board of directors approve of the change in the credit terms to customers from 2/10 net 30 to 3/10 net 30, if the required rate of return on equal-risk investments is 18%? Motivate your answer with the relevant calculations.

Answer rating: 100% (QA)

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