Example of Relaxing the credit period Basket Wonders is considering changing its credit period from net 30 which has resulted in 12A/R turns per year) to net 60 which is expected to result in 6 A/R turns per year) The firm is currently producing a single product with variable costs of $20 and a selling price of $25 Additional annual credit sales of $250, 000 from new customers are forecasted in addition to the current $2 million in annual credit sales. 10-11
10-11 Example of Relaxing the Credit Period Basket Wonders is considering changing its credit period from net 30 (which has resulted in 12 A/R turns per year) to net 60 (which is expected to result in 6 A/R turns per year). The firm is currently producing a single product with variable costs of $20 and a selling price of $25. Additional annual credit sales of $250,000 from new customers are forecasted, in addition to the current $2 million in annual credit sales
Example of Relaxing the credit period The before-tax opportunity cost for each dollar of funds died-up in additional receivables is 20% Ignoring any additional bad-debt losses that may arise, should Basket Wonders relax their credit period? 10-12
10-12 Example of Relaxing the Credit Period The before-tax opportunity cost for each dollar of funds died-up in additional receivables is 20%. Ignoring any additional bad-debt losses that may arise, should Basket Wonders relax their credit period?
Example of Relaxing the credit period Profitability of (5 contribution x(10,000 units) additional sales 50000 Additional ($250,000 sales)/(6 Turns)= receivables $41,667 Investment in add ($20/$25)X($41,667)= receivables(new sales)$33, 334 revIous $2,000,000 sales)/(12 Turns) receivable leve $166667 10-13
10-13 Example of Relaxing the Credit Period Profitability of ($5 contribution)x(10,000 units) = additional sales $50,000 Additional ($250,000 sales) / (6 Turns) = receivables $41,667 Investment in add. ($20/$25) x ($41,667) = receivables (new sales) $33,334 Previous ($2,000,000 sales) / (12 Turns) = receivable level $166,667
Example of Relaxing the credit period New ($2,000,000 sales)/(6 Turns)= receivable level $333,333 nvestment in $333,333-$166,667= add receivables $166,666 (original sales) Total investment in $33,334+$166,666 add receivables $200,000 Reg. pre-tax return (20% opp cost) x $200,000 on add. investment 40.000 10-14 Yes! Profits> Required pre-tax return
10-14 Example of Relaxing the Credit Period New ($2,000,000 sales) / (6 Turns) = receivable level $333,333 Investment in $333,333 - $166,667 = add. receivables $166,666 (original sales) Total investment in $33,334 + $166,666 = add. receivables $200,000 Req. pre-tax return (20% opp. cost) x $200,000 = on add. investment $40,000 Yes! Profits > Required pre-tax return
Credit and Collection Policies of the firm Quality of Length of Trade Account Credit period (1)Average Collection Period (2)Bad-debt Losses Firm Possible Cas Collection Discount Program 10-15
10-15 Credit and Collection Policies of the Firm (1) Average Collection Period (2) Bad-debt Losses Quality of Trade Account Length of Credit Period Possible Cash Discount Firm Collection Program