Unformatted text preview: nvestment in accounts receivable with the proposed cash discount is estimated to
be tied up for an average of 25 days instead of the 40 days under the original terms.
cMAX’s opportunity cost of funds is 14%. EXAMPLE MAX Company has an average collection period of 40 days (turnover
360/40 9). In accordance with the firm’s credit terms of net 30, this period is
divided into 32 days until the customers place their payments in the mail (not
everyone pays within 30 days) and 8 days to receive, process, and collect payments once they are mailed. MAX is considering initiating a cash discount by
changing its credit terms from net 30 to 2/10 net 30. The firm expects this change
to reduce the amount of time until the payments are placed in the mail, resulting
in an average collection period of 25 days (turnover 360/25 14.4).
As noted earlier in the EOQ example (page 609), MAX has a raw material
with current annual usage of 1,100 units. Each finished product produced requires
1 unit of this raw material at a variable cost of $1,500 per unit, incurs another
$800 of variable cost in the production process, and sells for $3,000 on terms of
net 30. MAX estimates that 80% of its customers will take the 2% discou...
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