problem: Mississippi Delta Inc. has been selling switching equipment to computer companies on net 30 terms, in which payment is expected by thirty days from the invoice date. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purpose; prompt payers and laggards. Prompt payers [80% of Mississippi Delta’s customers] pay, on average, in thirty-five days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a two percent cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly 4,000 dollars. The manager expects fifty percent of the prompt payers to pay in exactly ten days and the average on the other half to slip to 40 days. He thinks that the twenty percent of the laggards will pay is ten days and the average on the others will slip to 70 days. Given these forecasts, he is not sure that the lost revenue from discount takers (who would then pay only 98 percent of the invoiced dollar amount) justifies the improved collection. The company’s yearly cost of capital is eleven percent.
[A] Using net present value calculations show the present value of the present collection experience.
[B] Based on your net present value analysis, should Mississippi Delta Inc. adopt the cash discount?
[C] Determine the net present value of the proposed 2/10, net 30 terms.