Relaxation of credit standards Lewis Enterprises is considering relaxing its cre
ID: 2416631 • Letter: R
Question
Relaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 13,000 to 14,300 units during the coming year; the average collection period is expected to increase from 45 to 65 days; and bad debts are expected to increase from 2% to 3.5% of sales. The sale price per unit is $39, and the variable cost per unit is $27. The firm's required return on equal-risk investments is 24.6%. Evaluate the proposed relaxation, and make a recommendation to the firm. The additional profit contribution from an increase in sales is $ 15,600'. (Round to the nearest dollar.) The cost from the increased marginal investment in A/R is $ (Round to the nearest dollar.)Explanation / Answer
Sales price per unit 39 Less: Variable cost per unit -27 Contribution Per Unit 12 Increase in Sales Unit (14300-13000) 1300 Additional Profit Contribution (1300*12) 15600 Average Investment in Proposed Plan : (14300 units*27*65)/365 68758 Average Investment in Present Plan : (13000 units*27*45)/365 43274 Marginal Investment in Account receivable (68758-43274) 25484 Required Return on Investment 24.60% Cost of Marginal Investment in Account receivable (25484*24.60%) -6269 Cost of Marginal Bad Debts Bad Debts, proposed plan (14300*39*3.5%) 19520 Bad Debts, present plan (13000*39*2%) 10140 Cost of Marginal Bad Debts (19520-10140) -9380 Net Loss from implementing proposed plan -49 The credit standards should not be relaxed since the proposed plan results in a loss.