Modern Kitchenware Co. Case 6
Cash Discount
Purpose: The case illustrates how the offering of a cash discount can affect the profitability of the firm.
Three different cash discount policies are evaluated in terms of cost, freed up funds and the associated
profitability. The impact of a cash discount on sales volume is also considered and has an impact on the
final decision in the case.
Relation to Text: The case should follow Chapter 7.
Complexity: The case is moderately complex. It should require 1 hour.
Solutions
1. Midpoint of
Days Outstanding Weights
Weighted Number
of Days
5 .010 .050
15 .075 1.125
2. 1/10, net 30 Policy
10% x 10 days = 1 day
2/10, net 30 Policy
25% x 10 days = 2.5 days
3/10, net 30 Policy
60% x 10 days = 6 days
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3. Accounts receivable = average collection period x average daily credit sales
1/10, net 30 policy 28 days x $54,274 = $1,519,672
It should be pointed out that if total credit sales billed remained the same under the three cash
4. Cost of cash discount: Total credit sales x percent using the discount x % discount.
Cash Discount
Total
Credit Sales
Percent
Using the
Discount
Percent
Discount
Cost of Cash
Discount
1/10, net 30 policy $18,000,000 x 10% x 1% = $ 18,000
5. Old accounts receivable – new accounts receivable = freed up funds
1/10, net 30 policy
6. The return is equal to the freed up funds times 18%
1/10, net 30 policy $ 480,328 x 18% = $ 86,459
7. Returns on freed up funds – cost of cash discounts = profit or loss
Return on
Freed up Funds
Cost of Cash
Discount
Profit
(loss)
1/10, net 30 policy $ 86,459 – $ 18,000 = $ 68,459
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of McGraw-Hill Education.
8. Increased profitability of Alternative 2 (2/10, net 30) under the assumption of a $1,000,000 increase
in sales.
–Lost profit on funds committed to accounts receivable
The total profit on Alternative 2 (2/10, net 30) of $90,217 now exceeds the profit of Alternative 1
(1/10, net 30) of $68,459 as computed in Question 7. The 2/10, net 30 policy should now be chosen.
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of McGraw-Hill Education.