Question

As treasurer of the Dragon Corporation, Henry Lee is worried about his bad debt ratio, which is currently running at 7%. The company currently has $40 million in sales. He believes that imposing a more stringent credit policy might reduce sales by 10% and reduce the bad debt ratio to 3%. If the cost of goods sold is 70% of the selling price, should Mr. Lee adopt the more stringent policy?

Answer 1

Solution:

Current profit,considering bad debt ratio=100-(70%+7%)

=23%

Amount of current profit=$40 million*23%=9.2 million

Revised profit,after considering bad debt=100-(70%+3%)

=27%

Revised sale=$40 million*90%=$36 million

Revised amount of profit=$36 million*27%=9.72 million

Benefit from stringent policy=$9.72 million-$9.20 million

=$0.52 million

Since benefit from apllication of stringent policy is positive,hence Mr. Lee should adopt the more stringent policy.