Comparative calendar-year financial data for a company are shown below:
(1) Accounts receivable turnover for 2008.
= Sales/Average receivable
=4.5 times
(2) Days' sales uncollected for 2008.
=365/ Accounts receivable turnover
=81 days
(3) Inventory turnover for 2008.
= COGS/Average inventory
=3.6 times
(4) Days' sales in inventory for 2008.
=365/ Inventory turnover
=101 days
Jimmy Jack, Inc. is considering relaxing its credit standards in order to meet a competitor's change in credit
policy. As a result of the proposed change, sales during the coming year are expected to increase 15%, from
5,000 cars to 5,750 cars, the average collection period is expected to increase from 35 days to 45 days, and bad
debts are expected to increase from 2% to 3%. The average sale price per unit is $1,000 and the variable cost
per unit is $850. The firm's required return on investment is 10%.
Evaluate the proposed change in credit standards and make a recommendation to the business. Show all work.
We have to do the cost benefit analysis:
Cost of the Investment in receivables= Increase in Interest cost + Increase in Bad debts
Increase in interest cost= Interest rate*((New investments in Receivables)- Old Investments in receivables)
Increase in Bad Debts
Cost = 22945+72500
Benefit= Increase in Profits
=New Sales* Contribution Margin – Old Sales* Contribution Margin
Savings= Benefit-Cost
=$17055 = Answer
Hence it should accept the policy as the Savings are in positive.