Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed its terms to 2/10, EOM, net 60. The initial effect of the changed terms is as follows:

* Some customers deduct the cash discount even though they pay after the
specified date.
Calculate the effect of the changed terms. Assume
• Sales volume is unchanged.
• The interest rate is 12 percent.
• There are no defaults.
• Cost of goods sold is 80 percent of sales.

8 Look back at Practice Question 7. Assume that the change in credit terms results in a 2 percent increase in sales. Recalculate the effect of the changed credit terms.

To calculate the effect of the changed terms, we need to consider the impact on the collection period and the cash discount taken by customers.

1. Calculate the new collection period:
The collection period is the average number of days it takes for customers to pay.
Previously, the average collection period was 75 days.
With the new terms of 2/10, EOM, net 60, it means customers can take a 2% cash discount if they pay within 10 days from the end of the month. If they don't take the discount, the net payment is due within 60 days.
So, the new collection period is 10 + 60 = 70 days.

2. Calculate the discount lost due to late payment:
If some customers deduct the cash discount even though they pay after the specified date, it means they are taking the discount but not paying within the discount period.
To calculate the lost discount, we need to determine the portion of customers who take the discount and pay after the specified date. Let's assume this portion is 20% (you can adjust this assumption based on the specific situation).
The lost discount is the 2% cash discount multiplied by the portion of customers who take it but pay late. In this case, it is 2% * 20% = 0.4%.

3. Calculate the opportunity cost of the lost discount:
The opportunity cost is the cost of not taking the discount and paying later, which is the interest cost of financing the payment for the additional days.
The interest rate is given as 12 percent.
To calculate the opportunity cost, we multiply the lost discount (0.4%) by the interest rate (12%) to get 0.4% * 12% = 0.048%.

4. Calculate the net effect on profit:
a. Without the 2% increase in sales:
The net effect on profit is the difference between the lost discount (0.4%) and the opportunity cost (0.048%).
So, the net effect is 0.4% - 0.048% = 0.352%.

b. With the 2% increase in sales:
If there is a 2% increase in sales volume, we need to factor that in.
Let's assume the total sales amount is $100,000 (you can adjust this assumption based on the specific situation).
The cost of goods sold (COGS) is 80% of sales, so COGS is $100,000 * 80% = $80,000.
Without the 2% increase, the net effect on profit is $100,000 * 0.352% = $352.
With the 2% increase, the net effect on profit will be higher by 2%, so the additional profit is $100,000 * 2% = $2,000.

Therefore, with the 2% increase, the net effect on profit is the sum of the original net effect ($352) and the additional profit ($2,000).
So, the new net effect on profit is $352 + $2,000 = $2,352.