East Lansing Appliances (ELA) expects to have sales this year of $15 million und
ID: 2677334 • Letter: E
Question
East Lansing Appliances (ELA) expects to have sales this year of $15 million under its current creditpolicy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and the bad
debt loss percentage is 5 percent. Since ELA wants to improve its profitability, the treasurer has
proposed that the credit period be shortened to 15 days. This change would reduce expected sales
by $500,000, but it would also shorten the DSO on the remaining sales to 30 days. Expected bad
debt losses on the remaining sales would fall to 3 percent. The variable cost percentage is 60
percent, and the cost of capital is 15 percent.
What would be the incremental bad losses if the change were made?
a. $315,000
b. $260,500
c. -$260,500 (bad debt losses would decline)
d. -$315,000 (Bad debt losses would decline)
e. $0 (no change would occur)
Explanation / Answer
East Lansing Appliances (ELA) 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. Since ELA wants to improve its profitability, the treasurer has
proposed that the credit period be shortened to 15 days. This change would reduce expected sales
by $500,000, but it would also shorten the DSO on the remaining sales to 30 days. Expected bad
debt losses on the remaining sales would fall to 3 percent. The variable cost percentage is 60
percent, and the cost of capital is 15 percent.
What would be the incremental bad losses if the change were made?
a. $315,000
b. $260,500
c. -$260,500 (bad debt losses would decline)
d. -$315,000 (Bad debt losses would decline)
e. $0 (no change would occur)
Bad debt losses old: (.05)
($15,000,000) = $750,000.
Bad debt losses new: (.03)
($14,500,000) = $435,000.
Change in bad debt losses = $435,000 - $750,000 = -$315,000.
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