Kitchen Enterprises is evaluating a proposal to lengthen its credit period from 30 to 45 days. All customers will continue to pay on the net date. Currently, credit sales are $650,000 and variable costs are $455,000. The selling price is $20 per unit. The proposal is expected to lead to credit sales of $710,000. However, bad debts are expected to increase from 1% to 2% of sales. The required rate of return on equal-risk investments is 16.5%. (Note: Assume a 365-day year.) 1) Calculate the additional profit contribution from sales if the proposal is implemented. 2) Calculate the cost of the marginal bad debts. 3) Should the proposal be implemented? Explain.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Kitchen Enterprises is evaluating a proposal to lengthen its credit period from 30 to 45 days. All customers will continue to pay on the net date. Currently, credit sales are $650,000 and variable costs are $455,000. The selling price is $20 per unit. The proposal is expected to lead to credit sales of $710,000. However,
1) Calculate the additional profit contribution from sales if the proposal is implemented.
2) Calculate the cost of the marginal bad debts.
3) Should the proposal be implemented? Explain.
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