Warren Motor Company sells $30 million of its products to wholesalers on terms of "net 30." Currently, the firm's average collection period is 48 days. To speed up the collection of receivables, Warren is considering offering a cash discount of 2% if customers pay their bills within 10 days. The firm expects 50% of its customers to take the discount and its average collection period to decline to 30 days. The firm's required pretax return (i.e., opportunity cost) on receivables investment is 16%. Determine the cost of the cash discounts to Warren.

Question

Quizplus · Accepted Answer

The cost of the cash discounts to Warren can be calculated as follows: If 50% of customers take advantage of the 2% discount on $30 million in sales, the discount cost is 0.5 * 0.02 * $30,000,000 = $300,000.

Warren Motor Company Sells $30 Million of Its Products to Wholesalers