Frank\'s Formals rents apparel throughout the year. They have experienced non-pa

Question

Frank's Formals rents apparel throughout the year. They have experienced non-payment by about 15% of their customers with an average loss of $400. Frank's wants to stem their losses by using an instant electronic credit check on the customer. These checks will cost them $15 on each of the 1,000 customers. The opportunity cost is 2.0% for the credit period. Should they pursue the credit check?

No, because the $15,000 cost is too high.

No, because a $400 loss is minor.

Yes, because the net gain is $30,000.

Yes, because the net gain is $45,000.

Yes, because the net gain is $60,000.

Explanation / Answer

Answer:

1. The loss incurred before credit check is $ 400 (average loss) x 150 (number of non paying customers; 15% of 1,000) = $ 60,000

therefore, if the loss is prevented by practising instant electronic check then the total saving will be $ 60,000

2. Cost of pursuing instant credit check is $ 15,000 ($ 15 per customer that is $ 15 x 1,000 customers)

therefore, by incurring a cost of $ 15,000 the Company can save losses to the tune of $ 60,000 hence, there is a gain of $ 45,000 ($ 60,000 - $ 15,000). So, the Company should pursue the credit check. Also we can consider the opportunity cost of funds involved in the credit check at the rate of 2% that is $ 300. However, on the basis of options given in question we conclude that the most appropriate answer is;

Fourth Option; Yes, because the net gain is $45,000.

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.