Detailed Answer
Answer (B) is correct. To calculate the firm’s net cost of adding the cash discount to its credit terms, find both the total cash lost to discounts and the offsetting savings which arise from earlier customer payments. The calculations are as follows: Cash to be discounted = $5,000,000 × 60% = $3,000,000 Cost of discount = $3,000,000 × 2% = $60,000 Average daily sales = $5,000,000 ÷ 365 days = $13,698.63 per day Cost of A/R for 60 days = $13,698.63 × 60 days × 12% = $98,630.14 Cost of A/R for 30 days = $13,698.63 × 30 days × 12 $49,315.07 Savings from discount = $98,630.14 – $49,315.07 $49,315.07 Net cost of discount = $60,000 (cost) – $49,315 (savings) = $10,685