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 48 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? Do not round intermediate calculations.
A) $25,747
B) $31,927
C) $31,669
D) $22,143
E) $22,915

Question

Quizplus · Accepted Answer

The correct answer is A.The firm can earn a 2% discount by paying within 10 days instead of 48 days. The firm's net purchases are $11,760 per day, so the total discount that the firm can earn is $11,760 * 0.02 * 365 = $855,840. The interest expense on the notes payable is $11,760 * 0.10 * 365 = $427,920. The net income increase is $855,840 - $427,920 = $427,920. The tax savings on the interest expense is $427,920 * 0.40 = $171,168. The net income increase after taxes is $427,920 - $171,168 = $256,752.

Gonzales Company Currently Uses Maximum Trade Credit by Not Taking