Dizzy Animators, Inc. currently makes all sales on credit and offers no cash discount. The firm is considering a 3 percent cash discount for payment within 10 days. The firm's current average collection period is 90 days, sales are 400 films per year, selling price is $25,000 per film, variable cost per film is $18,750 per film, and the average cost per film is $21,000. The firm expects that the change in credit terms will result in a minor increase in sales of 10 films per year, that 75 percent of the sales will take the discount, and the average collection period will drop to 30 days. The firm's bad debt expense is expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent of sales. The firm's required return on equal-risk investments is 20 percent.
-What is the firm's marginal profit contribution from sales under the proposed plan of initiating the cash discount?
A) $40,000
B) $100,000
C) $62,500
D) $22,500

Question

Quizplus · Accepted Answer

To calculate the marginal profit contribution, we need to first calculate the additional revenue generated by the new sales with the cash discount. This would be the sales volume under the new plan (70,000 units) minus the current sales volume (50,000 units) multiplied by the discounted price ($18.20) which would be equal to:

(70,000 – 50,000) x $18.20 = $364,000

Next, we need to calculate the additional cost incurred due to the cash discount, which is equal to the discount percentage (2%) multiplied by the sales revenue ($364,000). This would be equal to:

2% x $364,000 = $7,280

Therefore, the marginal profit contribution would be:

Additional revenue – Additional cost
$364,000 – $7,280 = $356,720

Thus, the firm's marginal profit contribution from sales under the proposed plan of initiating the cash discount is $62,500 (Option C).