Your first major assignment after your recent promotion at Ice Nine involves overseeing the management of accounts receiv- be able and inventory. The first item that you must attend to in- volves a proposed change in credit policy that would involve relaxing credit terms from the existing terms of 1/50, net 70 to 2/60, net 90 in hopes of securing new sales. The management at Ice Nine does not expect bad debt losses on its current customers to change under the new credit policy. The following information should aid you in the analysis of this problem. New sales level (all credit) $8,000,000 Original sales level (all credit) $7,000,000 Contribution margin 25% Percent bad debt losses on new sales 8% New average collection period 75 days Original average collection period 60 days Additional investment in inventory $50,000 Pre-tax required rate of return 15% New percent cash discount 2% Percent of customers taking the new cash discount 50% Original percent cash discount 1% Percent of customers taking the old cash discount 50% To help in your decision on relaxing credit terms, you have been asked to respond to the following questions: (a) What determines the size of the investment Ice Nine makes in accounts receivables? (b) If a firm currently buys Ice Nine on trade credit with the present terms of 1/50, net 70 and decides to forgo the trade credit discount and pay on a net day, what is the annualized cost to that firm of forgoing the discount? (c) If Ice Nine changes its trade credit terms to 2/60, net 90, what is the annualized cost to a firm that buys on credit from Ice Nine and decides to forgo the trade credit discount and pay on a net day? (d) What is the estimated change in profits resulting from the increased sales less any additional bad debts associated with the proposed change in credit policy?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter18: The Management Of Accounts Receivable And Inventories

Section: Chapter Questions

Problem 8P

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Your first major assignment after your recent promotion at Ice Nine involves overseeing the management of accounts receiv- be able and inventory. The first item that you must attend to in- volves a proposed change in credit policy that would involve relaxing credit terms from the existing terms of 1/50, net 70 to 2/60, net 90 in hopes of securing new sales. The management at Ice Nine does not expect bad debt losses on its current customers to change under the new credit policy. The following information should aid you in the analysis of this problem.

New sales level (all credit)	$8,000,000
Original sales level (all credit)	$7,000,000
Contribution margin	25%
Percent bad debt losses on new sales	8%
New average collection period	75 days
Original average collection period	60 days
Additional investment in inventory	$50,000
Pre-tax required rate of return	15%
New percent cash discount	2%
Percent of customers taking the new cash discount	50%
Original percent cash discount	1%
Percent of customers taking the old cash discount	50%

To help in your decision on relaxing credit terms, you have been asked to respond to the following questions:

(a) What determines the size of the investment Ice Nine makes in accounts receivables?

(b) If a firm currently buys Ice Nine on trade credit with the present terms of 1/50, net 70 and decides to forgo the trade credit discount and pay on a net day, what is the annualized cost to that firm of forgoing the discount?

(c) If Ice Nine changes its trade credit terms to 2/60, net 90, what is the annualized cost to a firm that buys on credit from Ice Nine and decides to forgo the trade credit discount and pay on a net day?

(d) What is the estimated change in profits resulting from the increased sales less any additional bad debts associated with the proposed change in credit policy?

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