Gonzales Company

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 1

Gonzales Company currently 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 in 30 days. 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 after
taxes? a. –$23,520 b. –$31,440 c. +$23,520 d. +$38,448 e. +$69,888

Calculate A/P with and without taking discounts:


A/PNo discount = $11,760  30 days = $352,800.
A/PDiscount = $11,760  10 days = $117,600.

Calculate financing amount in notes payable and interest cost. The firm will need
to borrow the difference in notes payable.
$352,800 – $117,600 = $235,200.
The additional interest cost is $235,200  0.10 = $23,520.

Calculate total purchases and discounts lost:


Total purchases = 365 days  12,000 gross purchases = $4,380,000.
Discounts lost = $4,380,000  0.02 = $87,600.
Find the expected increase in net income:
Pre-tax savings = $87,600 – $23,520 = $64,080
After-tax savings = $64,080(1 – 0.4) = $38,448.

Alternative Approach: Construct comparative financial statements


I. Partial balance sheet:
Take Discounts Don’t Take Discounts
(Borrow N/P) (Use Max. A/P)
Difference
Accounts payable $117,600 $352,800 -$235,200
Notes payable (10%) 235,200 – +235,200
Total current liab. $352,800 $352,800 $ 0

II. Partial income statement:


EBIT* $140,000 $140,000 $ 0
Less: Interest 23,520 0
Discounts lost 0 87,600
EBT $116,480 $ 52,400 +$ 64,080
Less: Taxes (at 40%) 46,592 20,960 + 25,632
Net income $ 69,888 $ 31,440 +$ 38,448

*Any EBIT can be used, since the difference in EBIT from the two policies is zero.

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy