Question

Winslow Corporation (WC) sells its stainless steel products on terms of “2/15, net 45”. WC is considering granting credit to retailers with total assets as low as $500,000. Currently the lowest asset limit is $750,000. WC believes sales will increase $10 million from the new credit group but the average collection period for this new group will be 75 days versus the current average collection period of 40 days. If management estimates that 30% of the new customers will take the cash discount, but 10% of the new business, will be written-off as bad-debt loss, should WC lower its credit standards? Assume WC’s variable cost ratio is 0.8 and its required pretax rate of return on current assets investment is 15%. WC also estimates that an additional investment in inventory of $1,00,000 is necessary for the anticipated sales increase.

Answer 1

Particulars	Amount
Increase in sales due to acceptance of new customer	1000000
Less: Variable Cost	800000
Contribution from new sales	200000
Less: Bad debt due to increase in sales	100000
Less: Interest on investment because of additional inventory cost	15000
Less: Increase in cash discount	6000
Less: Oppurtunity Cost of Debtors (Note-1)	8630
Profit before tax	70370
Note- 1 Opportunity Cost of Debtors
Incremental Debtors = 10,00,000 - 3,00,000-1,00,000	600000
Debtor's of 6,00,000 will be blocked for additional 35 days
Interest	8630