Q. No. 2. Daud Tools: To Relax or Not? A Credit Policy Dilemma
Daud Tools
Full Question:
Daud Tools, a manufacturer of lathe tools, is currently selling a product for $10 per
unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is
$6. The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is expected to
result in the following; a 5% increase in unit sales to 63,000 units; an increase in
average collection period from 30 days (the current level) to 45 days; an increase in bad
debt expenses from 1% of sales (current level) to 2%. The firm determines that its cost
of tying up funds in receivables is 15% before taxes.
Question: Determine whether it would be profitable for Daud Tools to relax its credit
standards. To arrive at your decision, show the calculation of;
(a) Additional profit contribution from sales
(b) Cost of marginal investment in account receivables
(c) Cost of marginal investment in bad debts
Answer
a. Extra benefit commitment from deals
b. Cost of minor interest in accounts receivables
c. Cost of negligible interest in terrible obligations
(a) Additional Profit Contribution from Sales
(b) Cost of Marginal Investment in Accounts Receivables
(c) Cost of Marginal Investment in Bad Debts
Summary of Results:
Additional profit contribution from sales = $12,000
Cost of marginal investment in accounts receivables = $3,937.50
Cost of marginal investment in bad debts = $6,600
Conclusion:
