Reference no: EM132803298

International Electric plc at present offers its customers 30 days' credit. Half of the customers, by value, pay on time. The other half takes an average of 70 days to pay. The business is considering offering a cash discount of 2 percent to its customers for payment within 30 days.

The credit controller anticipates that half of the customers who now take an average of 70 days to pay (that is, a quarter of all customers) will pay in 30 days. The other half (the final quarter) will still take an average of 70 days to pay.

The scheme will also reduce bad debts by £300,000 a year. Annual sales revenue of £365 million is made evenly throughout the year. At present, the business has a large overdraft (£60 million) with its bank at an interest cost of 12 percent a year.

Questions:

(a) Calculate the approximate equivalent annual percentage cost of a discount of 2 percent, which reduces the time taken by credit customers to pay from 70 days to 30 days. (This part can be answered without reference to the narrative above.)

(b) Calculate the value of trade receivables outstanding under both the old and new schemes.

(c) How much will the scheme cost the business in discounts?

(d) Should the business go ahead with the scheme? What other factors, if any, should be taken into account.