Making changes to a firm\'s credit policy involves trade-offs. Assuming that all
ID: 2780207 • Letter: M
Question
Making changes to a firm's credit policy involves trade-offs. Assuming that all other factors remain constant, which of the following are outcomes expected to result from an increase in a firm's cash discount? Check all that apply. An increase in the creditworthiness of the firm's customers An increase in the firm's bad-debt expenses An increase in the cost of the discounts given An increase in the firm's credit sales, a speeding up of customer payments, and a reduction in the firm's receivables investment Consider the case of Virginia Hydroponics Company: Virginia Hydroponics Company (VHC), a wholesaler of seeds and plant nursery products, currently sells on terms of net 45 to its customers but is experiencing an average collection period (ACP) of 105 days. In an effort to reduce this delay, VHC's management is considering implementing its first cash discount. The revised credit terms, 4/25 net 45, are expected to reduce its ACP to 75 days. VHC expects 16% of its customers to take the discount, but it does not expect its inventory level to change as a result of the policy change. VHC has annual sales of $5,500,000 and incurs variable costs of 65%. VHC wants to earn a pretax return of 12% on its receivables investment. Given this data, answer the following questions, and round all final dollar amounts to the nearest dollar A VHC's average receivables balance is expected to exhibit an incremental change of 8. VHC should expect to generate receivables investment. in additional earnings as a result of the reduction in its C. VHC will sacrifice D. VHC should expect to see a net change of E. The company in cash discounts. in its pretax earnings. make the change to its credit policy Grade It NowExplanation / Answer
Cash discounts are given to incentivize customers to pay off their debts sooner. This improves their creditworthiness of firm's customers as they are now more likly to settle the debt sooner and decreases bad debts. Although this increases the costs of discount but it also reduces the receivables as customers pay up to avail the discount.
Therefore A, C and D are correct.
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Credit term : 4/25 net 45
% of customers taking discounts = 16%
Credit Sales = $5,500,000
Cash Discount = 4%
Credit Sales due to cash discount = $5,500,000 *16%
Return on Receivable investment = 12%
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A Receivables balance will go up by an amount equal to the Credit Sales = $5,500,000
B Investment in accounts receivable earlier = Credit Sales * ACP1/360 = $5500000 *105/360 = $1604166.67
Investment in accounts receivable now = Credit Sales * ACP2/360 = $5500000 *75/360 = $1145833.33
Difference in the two investments = $458333.33
C Cost of cash discount = Credit Sales due to cash discount * Cash discount%
=$5,500,000 * 16% * cash discount% = $35200
D
Amount prepaid by buyers = Credit Sales due to cash discount * (1-Cash discount%) = $5,500,000 * 16% * (1- cash discount%) = $844800
This is the amount receivable is reduced by.
E Must
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