UO, Inc., is evaluating its present credit policy and is concerned that it may not be offering terms that are competitive. Presently, they offer terms of 1/10, net 30, with 50% of its customers paying within the discount period and the remainder paying within the net period. UO’s credit department has projected that if the terms were changed
to 2/10, net 30, without changing the 25% contribution margin, annual credit sales will increase from $20 million to $30 million, with 75% of customers paying within ten days and the remainder paying within the net period. This change will decrease its days of credit from 20 to 15 days. UO’s opportunity cost for its accounts receivable investment is 15% before taxes.
a. What is the cost to UO of changing its discount?
b. What is the change in the carrying cost of accounts receivable for UO?
c. Should UO change its discount? Explain.