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WQZ Co could introduce an early settlement discount of 1% for customers who pay within
30 days and at the same time, through improved operational procedures, maintain a
maximum average payment period of 60 days for credit customers who do not take the
discount. It is expected that 25% of credit customers will take the discount if it were
offered.It is expected that administration and operating cost savings of $753,000 per year will be
made after improving operational procedures and introducing the early settlement
discount.
Credit sales of WQZ Co are currently $87.6 million per year and trade receivables are
currently $18 million. Credit sales are not expected to change as a result of the changes in
receivables management. The company has a cost of short?term finance of 5.5% per yearAssuming that only 25% of customers take the
early settlement discount, what is the maximum early settlement discount that
could be offered? ?I got the wrong answer here. Can you show me how to calculate this. I have already watched opentuition lectures .
I assume that you got are OK with the first bit of part (c) of the question and so are happy that if there is a 25% discount then the cost of giving the discount is $219,000 (1% x 25% x $87.6m) and the total benefit of giving the discount is $1,050,000 (297,000 saving in finance costs and 831,000 saving in admin and operating costs).
So with a discount of 1% there is a net benefit.
The maximum discount they could offer would be such that there was no net benefit. So if the discount was X%, then X/100 x 25% x $87,600,000 would be equal to $1,050,000.
So X = 1,050,000 / (25% x 87,600,000) = 4.8%,
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