"COMPREHENSIVE PROBLEMBailey Distributing Company sells small appliances to hardware stores in the southern Californiaarea. Michael Bailey, the president of the company, is thinking about changing the credit policiesoffered by the firm to attract customers away from competitors. The current policy calls for a1/10, net 30, and the new policy would call for a 3/10, net 50. Currently 40 percent of Baileycustomers are taking the discount, and it is anticipated that this number would go up to50 percent with the new discount policy. It is further anticipated that annual sales would increasefrom a level of $200,000 to $250,000 as a result of the change in the cash discount policy.The increased sales would also affect the inventory level. The average inventory carried byBailey is based on a determination of an EOQ. Assume unit sales of small appliances willincrease from 20,000 to 25,000 units. The ordering cost for each order is $100 and the carryingcost per unit is $1 (these values will not change with the discount). The average inventory isbased on EOQ/2. Each unit in inventory has an average cost of $6.50.Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are10 percent of net sales; and interest payments of 12 percent will be necessary only for theincrease in the accounts receivable and inventory balances. Taxes will equal 25 percent ofbefore-tax income. a. Compute the accounts receivable balance before and after the change in the cashdiscount policy. Use the net sales (Total sales – Cash discounts) to determine theaverage daily sales and the accounts receivable balances. b. Determine EOQ before and after the change in the cash discount policy. Translate thisinto average inventory (in units and dollars) before and after the change in the cashdiscount policy. c. Complete the income statement. Before Policy After PolicyChange ChangeNet sales (Sales – Cash discounts)Cost of goods soldGross profitGeneral and administrative expenseOperating profitInterest on increase in accounts receivable and inventory (12%)Income before taxesTaxesIncome after taxes d. Should the new cash discount policy be utilized? Briefly comment.S7-26 CP 7-1. Solution:Bailey Distributing Companya. Accounts receivable = average collection × average period daily salesBefore Policy ChangeAverage collection period.40 × 10 days = 4.60 × 30 days = 1822 daysAverage daily sales$200,000 - .01 .40 $200,000 Credit sales - Discount ( ) ( ) ( ) = 360 360 $200,000 - $800 = 360 $199,200 = 360 Average daily sales = $553.33 22 days × $553.33 = $12,173.26 accounts receivablebefore policy changeAfter Policy ChangeAverage collection period.50 × 10 days = 5.50 × 50 days = 2530 daysS7-27 CP 7-1. (Continued)Average daily sales$250,000 - .03 .50 $250,000 Credit sales - discount ( ) ( ) ( ) = 360 days 360 days $250,000 - $3,750 = 360 days $246,250 = 360 days Average daily sales = $684.03 Accounts receivable = 30 days × $684.03 = $20,520.83 afterpolicy changeb. Before2SOEOQ =C 2×× 20,000 $100 $4,000,000 = = 4,000,000 = 2,000 units $1 $1 After2×× 25,000 $100 $5,000,000 = = 5,000,000 = 2,236.07 units $1 $1 Before2,000 =1,000 units 1,000 units×= $6.50 $6,5002 After2,236.07 =1,118.04 units 1,118.04 units×= $6.50 $7,267.232 S7-28 CP 7-1. (Continued)c. Before Policy After PolicyChange ChangeNet sales (sales – cash discount) $199,200 $246,250.00Cost of goods sold (65%)129,480 160,063.00Gross Profit 69,720 86,187.00General and admin. expense (10%) 19,920 24,625.00Operating profit 49,800 61,562.00*Interest on increase in accountsreceivable and inventory1,093.79Income before taxes 49,800 60,468.21Taxes (25%)12,45015,117.05Income after taxes $ 37,350 $ 45,351.16*12%×= AR 12%× $20,520.90- $12,173.26 ( ) =12%×= $8,347.64 $1001.72 12%×= INV 12%× $7,267.26- $6,500 ( ) 92.07 =12%×= $767.26 $1093.79 d. The new cash discount policy should be utilized. The interestcost on the increased accounts receivable and inventory issmall in comparison to the increased operating profit fromthe policy change.S7-29 WEB EXERCISEOne of the items discussed in this chapter was the impact of the Internet on working capitalmanagement. FreeMarkets and Perfect Commerce are two companies that at the forefront of theB2B trend. Go to the Perfect Commerce Web site at www.perfect.com.1. Click on “Company” and read the description. In one short paragraph, describe whatPerfect Commerce does.2. List five of its key customers.3. Click on “Solutions.”4. Scroll down until you find “Perfect Source” in the right-hand column. Write down the threekey applications with a sentence about each.Note: From time to time, companies redesign their Web sites and occasionally a topic we havelisted may have been deleted, updated, or moved into a different location. If you click on the sitemap or site index, you will be introduced to a table of contents which should aid you in findingthe topic you are looking for. S7-30 "