Modern Kitchenware Co. Modem Kitchenware Co. specializes in the manufacturing and distribution of items used in the kitc

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Modern Kitchenware Co.
Modem Kitchenware Co. specializes in the manufacturing and
distribution of items used in the kitchen. Among its many products
are microwave ovens, toasters, electric can openers, etc. Its home
base is in Kansas City and the firm sells to retailers throughout
the US and Canada. Its customers range from small retail outlets in
strip shopping centers to major customers such as Sears and J. C.
Penney. In the most recent fiscal year, its sales were $18 million
with $2,500,000 in after tax profits
The firm's CEO is Beth Graham, who holds a B.A. in economics from
St. Louis University. Beth has moved up through the ranks as both a
product manager and VP of marketing
She has implemented an inventory control system that was thought by
many to be the finest in the kitchen supply industry. The
computer-based system kept hourly tabs on inventory in stock at
Kansas City as well as the ten distribution centers throughout the
country.
Management of Accounts Receivable
Beth felt a good deal less confident about the firm's ability to
control and manage the level of accounts receivable. Historically,
the finu shipped out its goods with a 30-day pay period allowed,
with no cash discount offered. An analysis of current accounts
receivable indicated the patter of receivables shown in Table
L
In looking over the numbers, Beth felt the customers, on average,
were taking over 30 days to pay. The receivables were bused on
average daily credit sales of $54,274 throughout the year.
Beth called in Al Becker, the chief financial officer, and asked
him what he thought the problem was. He said that because no cash
discount was being offered for early payment, customers were
sometimes lax in their payment pattern.
A Potential Cash Discount
Beth told Al to consider the impact of a
cash discount on the accounts receivable balance of the firm as
well as its profitability. Following Beth's instructions, Al
evaluated the effect of the three alternative cash discount
policies shown in Table 2.
He ran some pilot studies among customers and determined the
results below.
Ten percent of the customers would take advantage of the 1 percent
discount by paying within 10 days. If the two percent discount were
offered, 25 percent would take it, and if the 3 percent, discount
were offered, 60 percent of the customers would take advantage of
it. In cash case, it was assumed that those who do not take the
discount would pay at the end of 30
days.
Table 1. Accounts Receivables Outstanding, December 2013
Days Outstanding
0 - 10 days
Amount
10-20 days
20,000
20-30 days
150,000
30-40 days
650,000
430,000
40-50 days
50-60 days
350,000
Total A/R
Table 2. New Terms for Cash Discounts
Alternative
Terms
1
1/10, net 30
2
3
2/10, net 30.
3/10, net 30
He then computed the new average collection period(s) based on the
data in the prior paragraph. With an assumption of average daily
credit sales remaining at $54,274 per day, he also computed the
anticipated new accounts receivable balance based on the three
different cash discount policies.
He was informed by his corporate treasurer that any freed up funds
from accounts receivable could be used elsewhere in the corporation
to earn a return of 18 percent. All this information was reported
back to Beth, and she suggested that a thorough analysis be
conducted of all the implications of the cash discount
policies.
1. Compute the current average collection period based on the
data in Table 1. In doing this, multiply the midpoint of the days
outstanding, by the weight assigned to that category. For example,
the midpoint of the second company is 15 days and the category
represents 7.5 percent of total accounts receivable
($150,000/$2,000,000). Its value is 1.125 days (15 days. x .075).
After this process is followed for all six categories, add up the
total to get the average collection period.
2. Compute the new average collection period based on the terms in
Table 2 and the results of the pilot study. Use the simplifying
assumption that under the new policies all customers will all pay
at the end of the 10th day or the end of the 30th day.
i.e., for the 1/10, net 30 10% x 10 days = 1 day
90% × 30 days=27 days
28 days average collection period 3. Assuming average daily credit
sales remain at $54,274 per day, what will be the new accounts
receivable balance based on the three new cash discount policies?
Accounts receivable average collection period average daily =
credit sales
4. Compute the cost of the cash discount based on the three
policies under consideration. Recall that total credit sales were
$18 million. Multiply total credit sales times the percent that use
the discount for each new discount policy times the size of the
discount.
5. Compute the amount of freed up funds based on the three
different cash discount policies based on the following:
Old accounts receivable (given in table 1)
New accounts receivable (Question 3) Freed up funds
6. Assuming an 18 percent return can be carned on the freed up
funds, what is the return that can be earned under the three cash
discount policies?