Gonzales Company currently uses maximum trade credit by not taking discounts on its purchases.The standard industry credit terms offered by all its suppliers are 2/10,net 38 days,and the firm pays on time.The new CFO is considering borrowing from its bank,using short-term notes payable,and then taking discounts.The firm wants to determine the effect of this policy change on its net income.Its net purchases are $11,760 per day,using a 365-day year.The interest rate on the notes payable is 10%,and the tax rate is 40%.If the firm implements the plan,what is the expected change in net income?

Question

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The correct answer is A.The firm can save 2% on its purchases by taking discounts. The amount of the discount is $11,760 x 0.02 = $235.20 per day. The firm can take discounts for 28 days (38 days - 10 days) out of the year. So, the total amount of the discount is $235.20 x 28 = $6,585.60 per year.The interest expense on the notes payable is $11,760 x 0.10 x 28/365 = $924.80 per year.The net income effect is $6,585.60 - $924.80 = $5,660.80 per year.After-tax net income effect is $5,660.80 x (1 - 0.40) = $3,396.48 per year.

Gonzales Company Currently Uses Maximum Trade Credit by Not Taking