DSW Racing has annual credit sales of $800,000 on terms of net/30. A proposal to offer terms of 1/10, n/30 is being considered. The proposed discount is not expected to increase sales, but is expected to reduce ACP from the current level of 40 days to 30 days, and bad debt losses are expected to drop from 4% to 3.2%. DSW’s cost of capital is 9%
a) If 50% of DSW’s customers (based on dollar sales) take the new discount, what is the expected pre-tax net benefit of the proposal?
b) At what new bad-debt loss ratio would this proposal break even?