1 Accounts Receivable, Management. 2 Marginal Analysis Problem The Northern Muse Corp. is considering a change in credit policy. Managers are considering.

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Presentation transcript:

1 Accounts Receivable, Management

2 Marginal Analysis Problem The Northern Muse Corp. is considering a change in credit policy. Managers are considering extending credit to a riskier class of customer and extending their credit period from net 30 days to net 50 days. They do not expect bad debt losses on their current customers to change. Given the following information should they go ahead with the change in credit policy? New Sales level (all credit):$18,000,000 Original Sales level (all credit):$17,000,000 Contribution margin:20% % bad debt losses on new sales:8% New Average Collection Period:50 days Original Average Collection Period:30 days Additional Investment in Inventory:$60,000 Pre-tax required rate of return:15%

3 Step 1: Estimate the Change in Profit. = ($1,000,000 x.20) - ($1,000,000 x.08) = $200,000 - $80,000 = $120,000 New Sales level (all credit):$18,000,000 Original Sales level (all credit):$17,000,000 Contribution margin:20% % bad debt losses on new sales:8% New Average Collection Period:50 days Original Average Collection Period:30 days Additional Investment in Inventory:$60,000 Pre-tax required rate of return:15%

4 Step 2: Estimate the cost of additional investment in accounts receivable and inventory. Estimate the additional investment in accounts receivable: = ($18,000,000 / 360 x 50) - ($17,000,000 / 360 x 30) = $2,500,000 - $1,416,667 = $1,083,333 New Sales level (all credit):$18,000,000 Original Sales level (all credit):$17,000,000 Contribution margin:20% % bad debt losses on new sales:8% New Average Collection Period:50 days Original Average Collection Period:30 days Additional Investment in Inventory:$60,000 Pre-tax required rate of return:15% ACP= Acct Rec Crd Sales/360 Acct Rec=Crd Sales/360 x ACP

5 Additional accounts receivable and inventory times the required rate of return: = ($1,083,333 + $60,000).15 = $171,500 New Sales level (all credit):$18,000,000 Original Sales level (all credit):$17,000,000 Contribution margin:20% % bad debt losses on new sales:8% New Average Collection Period:50 days Original Average Collection Period:30 days Additional Investment in Inventory:$60,000 Pre-tax required rate of return:15%

6 Step 3: Estimate the change in the cost of the cash disct = $0 (no change) The Northern Muse Corp. is considering a change in credit policy. Managers are considering extending credit to a riskier class of customer and extending their credit period from net 30 days to net 50 days. They do not expect bad debt losses on their current customers to change. Given the following information should they go ahead with the change in credit policy?

7 Step 4: Compare the incremental rev with the incremental costs. = Step 1 - (Step 2 + Step 3) = $120,000 - $171,500 = - $51,500 The change should not be made.