Management of WC (Receivables) – Early Settlement Discount

Sir,

I would like to clarify with you about an example on early settlement discount from the ACCA website (https://www.accaglobal.com/hk/en/student/exam-support-resources/fundamentals-exams-study-resources/f9/technical-articles/alternative-receivables-collection-techniques.html).

Please find the question posted below for your reference:

Melvin Co has a turnover of $900,000 (90% of which is on credit) and receivable days are currently 42 despite the company only offering 30-days’ credit. Melvin Co finances its receivables using its overdraft which has an annual interest cost of 8% and has a contribution margin of 30%.

Melvin Co is considering the introduction of an early settlement discount at the same time as extending their standard credit terms to 50 days. The company would offer customers a 1% discount for payment within 14 days. It is anticipated that 40% of customers will take the discount, while those that do not take the discount will keep to the new standard credit terms. As a result of the extended credit terms, credit sales are expected to rise by 10%. Due to the extra administration involved it is thought that administration costs will rise by $10,000 per year.

Evaluate whether or not Melvin Co should offer the discount.

I have understood most of the steps to derive the answer for this question, which is to calculate:
– Cost of discount p.a.
– Current and New AR / AR days
– Savings/Benefits p.a.
– Net benefit / (cost)

However, the area that I am confused is the contribution margin part. The workings stated that the benefit that the company will gain from contribution margin is $24,300. To derive $24.3k will be:

Existing credit sales: $900,000 × 90% = $810,000
Expected increase in credit sales: $810,000 × 10% = $81,000
Contribution on extra sales: 81,000 × 30% = $24,300

May I clarify if the contribution margin is used to find the extra profit from the extra sales? That’s why it is included in the calculation of finding the net benefit? I guess I am confused of this particular concept of contribution margin.

Thank you for taking your time and I appreciate your help.