FMF9

Question 2b

KXP Co is an e-business which trades solely over the internet. In the last year the company had sales of $15 million. All sales were on 30 days’ credit to commercial customers.

Extracts from the company’s most recent statement of financial position relating to working capital are as follows:

Trade receivables 2,466,000
Trade payables 2,220,000
Overdraft 3,000,000

In order to encourage customers to pay on time, KXP Co proposes introducing an early settlement discount of 1% for payment within 30 days, while increasing its normal credit period to 45 days. It is expected that, on average, 50% of customers will take the discount and pay within 30 days, 30% of customers will pay after 45 days, and 20% of customers will not change their current paying behaviour.

KXP Co currently orders 15,000 units per month of Product Z, demand for which is constant. There is only one supplier of Product Z and the cost of Product Z purchases over the last year was $540,000. The supplier has offered a 2% discount for orders of Product Z of 30,000 units or more. Each order costs KXP Co $150 to place and the holding cost is 24 cents per unit per year.

KXP Co has an overdraft facility charging interest of 6% per year.

Required:

Calculate whether the bulk purchase discount offered by the supplier is financially acceptable and comment on the assumptions made by your calculation.