Firm A is trying to decide whether to offer a 3.0% cash discount for payments made within 10 days, making its new terms 3/10, net 30. On average, its paying customers currently pay in 40 days under its present terms of net 30. A sales analyst estimates that sales will stay the same. The existing bad-debt loss rate is 3%; the rate under the new policy will be the same. It is estimated that 40% of the paying customers will take the discount and pay on the 10th day, on average. The remaining paying customers will continue to pay in 40 days, on average. The company’s annual cost of capital is 10%. Annual sales will remain unchanged at $250 million, and the variable cost ratio will continue to be 60%. The variable expenses for credit administration and collections will drop from 5% to 4% if the cash discount is implemented.
1. What is the 1-day change in value related to the proposed terms?
2. What is the change in daily net present value related to the proposed terms?
3. Do you recommend that the firm initiate the discount?
4. What is the optimal cash discount percent for the firm?