Firm A expects to have sales of $15 million under its current credit policy. The

Question

Firm A expects to have sales 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. 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 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 debt losses if the change were made?

Choices are a) $315,000; b) 260,500, c) -260,500 (decline in bad debt losses); d) -$315,000 (decline in bad debt losses); e) $0 (no chnge would occur).

Explanation / Answer

Bad debt losses old: (0.05)($15,000,000) = $750,000.
Bad debt losses new: (0.03)($14,500,000) = $435,000.
Change in bad debt losses = $435,000 - $750,000 = -$315,000.

So (D)-$315,000 (decline in bad debt losses)

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