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.
Well, let's calculate the effect of the changed terms, shall we?
Since the sales volume is unchanged, we can keep that constant. The only thing we need to consider is the cash discount and how it affects the timing of payments.
With the new terms of 2/10, EOM, net 60, customers are now offered a 2% cash discount if they pay within 10 days. However, the net payment is still due in 60 days.
So, some customers may take advantage of the cash discount even if they pay after the specified date. This means that Augean Cleaning Products might receive some payments 10 days after the invoice date, but still get the full amount.
To calculate the effect, we need to consider the cost of goods sold, which is 80% of sales. Let's assume the average customer has a $100 invoice.
Without the cash discount, the customer would pay after 75 days, so the present value of their payment would be:
PV = $100 / (1 + 0.12)^(75/365) = $82.78
But with the cash discount, if the customer pays within 10 days, they only have to pay $98 (2% off the $100 invoice). So, the present value of their payment with the cash discount and paying within 10 days would be:
PV = $98 / (1 + 0.12)^(10/365) = $97.27
Now, let's calculate the difference in present value between the two scenarios:
Difference = $97.27 - $82.78 = $14.49
So, the initial effect of the changed terms is that Augean Cleaning Products would receive $14.49 more in present value for each $100 invoice on average.
To calculate the effect of the changed terms, we need to consider the following:
1. Calculation of the cash discount:
The new terms are 2/10, EOM, net 60. This means that customers can deduct a 2% cash discount if they pay within 10 days from the end of the month.
2. Calculation of the average collection period under the new terms:
Previously, the average collection period was 75 days. With the new terms, customers are incentivized to pay within 10 days from the end of the month. Therefore, the average collection period would be reduced to approximately 40 days.
3. Calculation of the effective interest rate:
Since customers can deduct a 2% cash discount if they pay within 10 days, we can consider this as a reduction in the price of the products. The interest rate is 12%, so the effective interest rate would be 12% * (1-2%) = 11.76%.
4. Calculation of the cost of goods sold:
The cost of goods sold is 80% of sales.
Now, let's calculate the effect of the changed terms:
1. Reduction in collection period (Days):
Previous collection period: 75 days
New collection period: 40 days
Reduction: 75 - 40 = 35 days
2. Reduction in collection period (%):
Reduction in collection period / Previous collection period * 100
= 35 / 75 * 100
= 46.67%
3. Effective interest rate (%):
11.76%
4. Calculation of the annual reduction in collection costs:
Annual reduction in collection costs = (Reduction in collection period / 365 days) * Cost of goods sold * Effective interest rate
= (35 / 365) * 0.8 * 11.76%
= 0.003425 * 0.8 * 11.76%
= 0.002720 * 11.76%
= 0.031979%
Therefore, the initial effect of the changed terms is a reduction in collection costs by approximately 0.032%.
To calculate the effect of the changed terms on Augean Cleaning Products, we need to consider the cash discount, the interest cost, and the change in the average collection period.
The new terms for Augean Cleaning Products are 2/10, EOM, net 60. This means that customers will receive a 2% discount if they pay within 10 days from the end of the month. The net payment is due within 60 days.
1. Calculate the cash discount:
The cash discount is 2% of the total sales if paid within 10 days. Therefore, if customers take advantage of the discount, Augean Cleaning Products will receive 98% of the sales amount.
2. Calculate the interest cost:
The interest rate is given as 12% per annum. To calculate the interest cost per day, we divide the interest rate by the number of days in a year (365 days).
Interest cost per day = 12% / 365 = 0.03287%
3. Calculate the change in the average collection period:
The previous average collection period was 75 days. With the new terms, the net payment is due within 60 days. Therefore, the average collection period has been reduced by 15 days.
Now let's calculate the effect on Augean Cleaning Products using the given information and calculations:
1. Calculate the cash discount:
- For customers who take advantage of the cash discount, Augean Cleaning Products will receive 98% of the sales amount instead of the full amount.
2. Calculate the interest cost:
- We assume that customers who do not take advantage of the cash discount will pay on the 60th day. Therefore, the interest cost for those customers will be 60 days * 0.03287% per day.
3. Calculate the change in the average collection period:
- The reduction in the average collection period will result in customers paying 15 days earlier than before.
By calculating the cash discount, interest cost, and the change in the average collection period, you can determine the effect of the changed terms on Augean Cleaning Products.