Question

Norton Wrench, a machine-tool company, recently found out that one of its main competitors has tightened its credit standards. Norton's chief operating officer has asked you to make a recommendation to the executive policy committee on whether the company should tighten its standards. The marketing department estimates that annual sales will drop $20,000 from the current level of $275,000. The variable cost ratio is 0.7 and will not change, according to the cost accountants. Expenses related to collections and credit administration are projected at 1.25% of sales under the existing standards but 1.45% of sales under the proposed standards. The bad debt expense rate remain at 7%. The DSO of 56 days is not expected to change. The company's annual cost of capital is 15%. Calculate the new standard's 1 day change in value.

Answer 1

Norton Wrench - credit standards tightening.

Note: an annual nominal cost of 15% compounded daily implies an annual effective cost of { [ (1 + .15/365)^365 ] - 1 } * 100 = 16.18% per year.