Mississippi Delta, Inc. has been selling switching equipment to computer companies on net 30 terms, in which payment is expected by 30 days from invoice data. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purposes:
Prompt payors and laggards. Prompt payors (80% of Mississippi Delta’s customers) pay, on average, in 35 days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a 2% cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly $4,000. The manager expects 50% of the prompt payors to pay in exactly 10 days and the average on the other half to slip to 40 days. He thinks that 20% of the laggards will pay in 10 days and the average on the others will slip to 80 days. Given these forecasts, he is not sure that the lost revenue from discount takers (who would then pay only 98% of the invoiced dollar amount) justifies the improve collection. The company’s annual cost of capital is 11%.
Using NPV calculations, show the present value of the present collection experience.
Calculate the NPV if the proposed 2% discount for those paid in 10 days were to be taken
Based on your net present value analysis, should Mississippi Delta Inc. adopt the cash discount?