Question

Blueroot Inc. is considering a change in its financing policy. Currently, it 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 30 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?

Answer 1

Answer:

net income should increase by $38,448

Explanation:

net purchases per day = $11,760

net purchases x 20 days = $11,760 × 20 = $235,200

interest expense = $235,200 × 10%  = $23,520

the gross amount purchased during the 20 day period:  

= (net purchases × 365) ÷ (1 - discount rate)  = ($11,760 × 365 days) ÷ (1 - 0.02)   = $4,292,400 / 98% = $4,380,000

lost discounts = $4,380,000 × 2% = $87,600

the after tax change in net income = ($87,600 - $23,520) × (1 - 40%) = $64,080 × 60% = $38,448