Response to the following problem:
The El Cheapo Company typically has $1 million of sales each year and a contribution margin of 20%. El Cheapo is considering offering its customers a 1% discount if they pay within five days of the sale, otherwise full payment is due within 20 days.
a. What is the effective annual cost of credit to its customers if El Cheapo changes its policy and customers pay on the net day?
b. If sales are expected to increase to $2 million per year when this discount is instituted and if 30% of its customers are predicted to take advantage of this discount, what is the cost of the discount to El Cheapo?
c. What contribution margin would El Cheapo need to insure a 20% profit margin on those accounts paid within five days (ignoring any costs of carrying accounts receivable)?