Shortening the credit period A firm is contemplating shortening its credit perio

Question

Shortening the credit period A firm is contemplating shortening its credit period c from 40 to 30 days and believes that, as a result of this change, its average collection. Period will decline from 45 to 36 days. Bad-debt expenses are expected to decrease from 1.5% to 1% of sales. The firm is currently selling 12,000 units but believes that sales will decline to 10,000 units as a result of the proposed change. The sale price per unit is S56, and the variable cost per unit is $45. The firm has a required return on equal-risk investments of 25%. Evaluate this decision, and make a recommendation to the firm. (Note: Assume a 365-day year.)

Explanation / Answer

As there is Net loss of $ 11,972.05 from the proposed plan the firm should not accept the proposed plan.

Current Proposed Incremental Investment Credit Period days 40 30 Collection Period days 45 36 Bad Debt 1.50% 1% Units Sold units 12000 10000 Sales $(sales unit* $56 per unit) 672000 560000 Total variable cost $ (sales unit* $45 per unit) 540000 450000 Average Investment $          66,575.34          44,383.56 22,191.78 (540000*45/365) (540000*36/365) Marginal Bad debt $ 10080 5600 (672000*1.5%) (560000*1%) Cost of Marginal Investment $ (a)           5,547.95 (22191.78*25%) Cost of Marginal Bad debt $ (b)           4,480.00 (10080-5600) Additional Loss $ ( C)         (22,000.00) (12000 unit -10000unit)* ($56-$45) Net Loss from prosposed plan $ (a+b+c)         (11,972.05)

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