Van Doren housing expects to have sales this year of 15 million under its curren

Question

Van Doren housing expects to have sales this year of 15 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Also, Van Doren's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Van Doren wants to improve its porfitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is; change the credit terms to 2/10, net 30. The consultants predict that sales would increase by 500,000, and that 50 percent of all customers would take the discount. The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 4 percent. Please prepare the pro forma income statement to show the different net income of the company under the current and proposed policy based on the given information.

Explanation / Answer

Therewill be an increase in net income by $356,250.

Working:

Present Proposed Difference Sales 15000000 15500000 500000 Variable Cost (60%) 9000000 9300000 -300000 Contribution margin 6000000 6200000 200000 Expenses: Discount (2% on 50% of sales) 155000 -155000 Bad debt (4% of all sales) 750000 620000 130000 Interest Expense * 375000 193750 181250 Total expenses 1125000 968750 156250 Net income 4875000 5231250 356250 Note: Other costs being fixed will not have a bearing              on the decision to be made, hence not considered. DSO (Days) 60 30 Average outstanding receivables 2500000 1291667 (15,000,000*60/360) and (15,500,000*30/360) Interest @15% * (on outstanding receivables) 375000 193750

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