Intermediate Financial Management (MindTap Course List)
12th Edition
ISBN: 9781285850030
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 22, Problem 6P
Tightening Credit Terms
Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.5 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,375,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit.
Vinson’s variable cost ratio is 85%, and taxes are 40%. If the interest rate on funds invested in receivables is 18%, should the change in credit terms be made?
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Tightening Credit Terms
Kim Mitchell, the new credit manager of the Vinson Corporation, was
alarmed to find that Vinson sells on credit terms of net 90 days while
industry-wide credit terms have recently been lowered to net 30 days.
On annual credit sales of $2.18 million, Vinson currently averages 95
days of sales in accounts receivable. Mitchell estimates that tightening
the credit terms to 30 days would reduce annual sales to $2,055,000,
but accounts receivable would drop to 35 days of sales and the savings
on investment in them should more than overcome any loss in profit.
Vinson's variable cost ratio is 82%, taxes are 40%, and the interest rate
on funds invested in receivables is 21%. Assuming a 365-day year,
calculate the cost of carrying receivables under the current policy and
the new policy. Enter your answers as positive values. Do not round
intermediate calculations. Round your answers to the nearest dollar.
Current policy: $
New policy:
Should the change in credit terms be…
Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.32 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,195,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit. Assume that Vinson’s variable cost ratio is 79%, taxes are 40%, and the interest rate on funds invested in receivables is 18%.
Assuming a 365-day year, calculate the net income under the current policy and the new policy. Do not round intermediate calculations. Round your answers to the nearest dollar.
Current policy: $
New policy: $
Should the change in credit terms be made?
Peanut Inc. is evaluating whether to change its credit terms from 2/10 net 30 to 3/10 net 30. At present, 50% of Peanut's sales are paid at day 10. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on day 30 whereas the remainder will pay 15 days late (no bad debts exist). But as a result of the higher cash discount offered with the new terms, sales are expected to increase from 757,000 to 801,000 per year. Peanut's variable cost ratio is 75% and its cost of funds is 8.7%. All production costs are paid on the day of the sale. Should the change be made?
Chapter 22 Solutions
Intermediate Financial Management (MindTap Course List)
Ch. 22 - Prob. 1QCh. 22 - Prob. 2QCh. 22 - Is it true that if a firm calculates its days...Ch. 22 - Firm A had no credit losses last year, but 1% of...Ch. 22 - Indicate by a (+), (), or (0) whether each of the...Ch. 22 - Cost of Bank Loan On March 1, Minnerly Motors...Ch. 22 - Cost of Bank Loan Mary Jones recently obtained an...Ch. 22 - Del Hawley, owner of Hawleys Hardware, is...Ch. 22 - Gifts Galore Inc. borrowed 1.5 million from...Ch. 22 - Relaxing Collection Efforts The Boyd Corporation...
Ch. 22 - Tightening Credit Terms Kim Mitchell, the new...Ch. 22 - Effective Cost of Short-Term Credit Yonge...Ch. 22 - Monitoring of Receivables
The Russ Fogler Company,...Ch. 22 - Prob. 10PCh. 22 - Prob. 1MCCh. 22 - Prob. 2MCCh. 22 - Prob. 3MCCh. 22 - Prob. 4MCCh. 22 - Prob. 5MCCh. 22 - Prob. 6MCCh. 22 - Prob. 7MCCh. 22 - Assume that it is now July of Year 1 and that the...Ch. 22 - Now assume that it is several years later. The...Ch. 22 - Prob. 10MCCh. 22 - Prob. 11MCCh. 22 - Prob. 12MCCh. 22 - Prob. 13MCCh. 22 - Prob. 14MCCh. 22 - Suppose the firm makes the change but its...
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- ALei Industries has credit sales of $146 million a year. ALei's management reviewed its credit policy and decided that it wants to maintain an average collection period of 35 days. a. What is the maximum level of accounts receivable that ALei can carry and have a 35-day average collection period? b. If ALei's current accounts receivable collection period is 55 days, how much would it have to reduce its level of accounts receivable in order to achieve its goal of 35 days?arrow_forwardGive answer of this Question pleasearrow_forwardSolve thisarrow_forward
- Brown Corporation had average days of sales outstanding of 19 days in the most recent fi scal year. Brown wants to improve its credit policies and collection practices and decrease its collection period in the next fi scal year to match the industry average of 15 days. Credit sales in the most recent fi scal year were $300 million, and Brown expects credit sales to increase to $390 million in the next fi scal year. To achieve Brown’s goal of decreasing the collection period, the change in the average accounts receivable balance that must occur is closest to: C . –$1.22 million.arrow_forwardSolving the Correct answerarrow_forwardIngraham Inc. currently has $525,000 in accounts receivable, and its days sales outstanding (DSO) is 67 days. It wants to reduce its DSO to 20 days by pressuring more of its customers to pay their bills on time. If this policy is adopted, the company's average sales will fall by 15%. What will be the level of accounts receivable following the change? Assume a 365-day year. Do not round intermediate calculations. Round your answer to the nearest dollar. $arrow_forward
- Need Correct Answerarrow_forwardAxis Wells and Excavation (AWE) currently generates $110,000 in annual credit sales. AWE sells on terms of net 50, and its accounts receivable balance averages $11,000. AWE is considering a new credit policy with terms of net 25. Under the new policy, sales will decrease to $104,000, and accounts receivable will average $13,000. Compute the days sales outstanding (DSO) under the existing policy and the proposed policy. Assume there are 360 days in a year. Round your answers to the nearest whole number. DSO Existing: days DSO New: daysarrow_forwardRelaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 20% from 10,000 to 12,000 units during the coming year; the average collection period is expected to increase from 30 to 45 days; and bad debts are expected to increase from 1% to 3% of sales. The sale price per unit is $45, and the variable cost per unit is $34. The firm's required return on equal-risk investments is 10.3%. Evaluate the proposedrelaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)arrow_forward
- Accounts receivable changes with bad debts Clear Glass Company sells glass containers. It reported total sales of $1,580,000, with 60% of the sales on credit. It takes 60 days to collect accounts receivable. The selling price is $20 per container while the variable cost is $15 per container. The board is currently investigating a change in the collection of accounts receivable that is expected to result in a 20% increase in credit sales and a 10% increase in the average collection period. Bad debts will also increase, from 2% to 4% of sales. The firm’s opportunity cost on its investment in accounts receivable is 12%. (Note: Use a 365-day year.) Calculate bad debts in dollars for the current and proposed plans. Calculate the cost of the marginal bad debts to Clear Glass Company. Would you recommend the proposed plan? Explain. Under what circumstances would the decision to implement the proposed plan change?arrow_forwardRuth Company currently has $1,000,000 in accounts receivable. Its average collection period is is 50 days. Assume a 365-day year. The company wants to reduce its average collection period to the industry average of 32 days by pressuring more of its customers to pay their bills on time. The company's CFO estimates that if this policy is adopted the company's average sales will fall by 10 percent. Assuming that the company adopts this change and succeeds in reducing its DSo to 32 days and does lose 10 percent of its sales, what will be the level of accounts receivable following the change? this is a bonus question Select one: a. $900,000 b. $676,667 c. $776,000 d. $576,000 e. $976,667 IIIarrow_forwardSoler Inc. wishes to speed up collection of its receivables. Soler currently offers credit terms of net 30. It is considering changing to terms of 2/10 net 20. The collection period is expected to be reduced from 40 to 25 days. The percentage of customers paying within the discount period is expected to be 60 percent. Bad debt losses average 6 percent of sales and are expected to decrease to 5 percent under the proposed policy. The inventory level is expected to increase by $300,000. Annual billings are $50 million. The variable cost ratio is 75 percent. The pretax return on funds made available by this change in policy is 6 percent. Assuming the change in terms is made; determine the net effect on Soler’s pretax profits.arrow_forward
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