Question

Logan Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast. Joe Logan, the president of the company, is thinking about changing the firm’s credit policy to attract customers away from competitors. The present policy calls for a 1/10, net 30 cash discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of Logan customers are taking the discount, and it is anticipated that this number would go up to 50 percent with the new discount policy. It is further anticipated that annual sales would increase from a level of \(400,000 to \)600,000 as a result of the change in the cash discount policy. The increased sales would also affect the inventory level. The average inventory carried by Logan is based on a determination of an EOQ. Assume sales of fans and heaters increase from 15,000 to 22,500 units. The ordering cost for each order is \(200, and the carrying cost per unit is \)1.50 (these values will not change with the discount). The average inventory is based on EOQ/2. Each unit in inventory has an average cost of $12. Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are 15 percent of net sales; and interest payments of 14 percent will only be necessary for the increase in the accounts receivable and inventory balances. Taxes will be 40 percent of before-tax income.

c. Complete the following income statement:

	Before policy change	After policy change
Net sales (sales – cash discounts)
Cost of goods sold
Gross profit
General and administrative expenses
Operating profit
Interest on the increase in accounts receivable and inventory (14%)
Income before taxes
Taxes
Income after taxes

Short answer

The income after taxes before policy change is $47,856 and after policy change is $68,790.

Step-by-step solution

Income statement

	Before policy change	After policy change
Net sales (sales – cash discounts)	$398,800	$591,000
Cost of goods sold(65% of net sales)	$259,220	$384,150
Gross profit	$139,580	$206,850
General and administrative expenses (15% of net sales)	$59,820	$88,650
Operating profit	$79,760	$118,200
Interest on the increase in accounts receivable and inventory (14%)	-	$3,550
Income before taxes	$79,760	$114,650
Taxes (40%)	$31,904	$45,860
Income after taxes	$47,856	$68,790

Working notes

$\begin{array}{rcl}1)\mathrm{Interest}\mathrm{on}\mathrm{increase}\mathrm{in}\mathrm{accounts}\mathrm{receivable}& =& \mathrm{Interest}\mathrm{rate}\times \left(\mathrm{AR}\mathrm{after}\mathrm{policy}\mathrm{change}-\mathrm{AR}\hspace{0.17em}\mathrm{before}\mathrm{policy}\mathrm{change}\right)\\ & =& 14\%\times \left(\$49,250.10-\$26,586.72\right)\\ & =& 14\%\times \$22,663.38\\ & =& \$3,172.87\\ 2)\mathrm{Interest}\mathrm{on}\mathrm{increase}\mathrm{in}\mathrm{inventory}& =& \mathrm{Interest}\mathrm{rate}\times \left(\mathrm{Inventory}\mathrm{after}\mathrm{policy}\mathrm{change}-\mathrm{Inventory}\mathrm{before}\mathrm{policy}\mathrm{change}\right)\\ & =& 14\%\times \left(\$14,694-\$12,000\right)\\ & =& 14\%\times \$2,694\\ & =& \$377.16\\ 3)\mathrm{Total}\mathrm{interest}& =& \mathrm{Interest}\mathrm{on}\mathrm{AR}+\mathrm{Interest}\mathrm{on}\mathrm{inventory}\\ & =& \$3,172.87+\$377.16\\ & =& \$3,550\end{array}$