The Fierro Corporation has annual credit sales of $6 million.  Current expenses for the collection department are $100,000, bad debt losses are 4 percent, and the days sales outstanding is 30 days.  Fierro is considering easing its collection efforts so that collection expenses will be reduced to $50,000 per year.  The change is expected to increase bad debt losses to 7 percent and to increase the days sales outstanding to 45 days.  In addition, sales are expected to increase to $8 million per year.                         Should Fierro relax collection efforts, if the opportunity cost of funds is 10 percent, the variable cost ratio is 75 percent, and its marginal tax rate is 30 percent?  All costs associated with production and credit sales are paid on the day of the sale.

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Asked Dec 12, 2019
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The Fierro Corporation has annual credit sales of $6 million.  Current expenses for the collection department are $100,000, bad debt losses are 4 percent, and the days sales outstanding is 30 days.  Fierro is considering easing its collection efforts so that collection expenses will be reduced to $50,000 per year.  The change is expected to increase bad debt losses to 7 percent and to increase the days sales outstanding to 45 days.  In addition, sales are expected to increase to $8 million per year.

 

                        Should Fierro relax collection efforts, if the opportunity cost of funds is 10 percent, the variable cost ratio is 75 percent, and its marginal tax rate is 30 percent?  All costs associated with production and credit sales are paid on the day of the sale.

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Expert Answer

Step 1

Calculation of Incremental profit after tax using excel is as follows:

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Existing Plan Proposed Plan $6,000,000 $4,500,000| $1,500,000 1 Particulars 2 Sales 3 Less: Variable Cost Incremental $8,000,000 $6,000,000 $2,000,000 $2,000,000 $1,500,000 S500,000 4 Contribution 5 Less: 6 Collection Expense 7 Bad Debt 8 Profit Before Tax 9 Tax (30%) (S50,000)| $320,000 $230,000 $92,000 S138,000 $100,000 $240,000 | $1,160,000 $348,000 $812,000 $50,000 $560,000 $1,390,000 $417,000 $973,000 10 Profit After Tax

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Step 2

Formula used in the above table is as follows:

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Proposed Plan 8000000 |=C2*75% |=C2-C3 1 Particulars Existing Plan 6000000 |-B2*75% |=B2-B3 Incremental |=C2-B2 -С3-ВЗ |=D2-D3 2 Sales 3 Less: Variable Cost 4 Contribution 5 Less: 6 Collection Expense 7 Bad Debt 8 Profit Before Tax 9 Tax (30%) 10 Profit After Tax |=C6-B6 |=C7-B7 =D4-D6-D7 |=D8*40% |=DS-D9 100000 |=B2*4% |=B4-B6-B7 |=B8*30% =BS-B9 50000 |=C2*7% |=C4-C6-C7 |=C8*30% =C8-C9

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Step 3

Existing Plan:

Credit Sales = $6,000,000

Days Sales Outstanding = 30

Total Number of Days in a Year = 3...

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Credit Sales × Days Sales Outstanding Accounts Receivable = Total Number of Days in a Year $6, 000, 000 × 30 365 $180,000,000 365 = $493,150.68

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