Please I need help with this!! Framing Inc. is considering changing its credit p
ID: 2800214 • Letter: P
Question
Please I need help with this!!
Framing Inc. is considering changing its credit policy from “2/20 net 50” to “3/20 net 60”. The firm expects the policy change to increase sales 30% over the current $12 million level. Framing also expects the percentage of customers taking advantage of the discount to increase from 20% to 65% and the bad-debt loss ratio will increase from 3.7% to 4.2%. Framing expects the average collection period to decrease from 58 days to 52 days. Its variable cost ratio is 87% and its required return on A/R investments is 15%. Should Framing adopt the new policy?
Question options:
a) Yes, the difference between marginal benefits and marginal costs is $468,000
b) No, the difference between marginal benefits and marginal costs is ($315,016)
c) Yes, the difference between marginal benefits and marginal costs is $256,800
d) No, the difference between marginal benefits and marginal costs is ($46,743)
Explanation / Answer
Variable cost ratio = 87%
Profit Margin = 13%
Cost-Benefit Analysis
Benefits:
Increase in Profit = 12,000,000 x 30% x 13% = $4,68,000
Costs:
Increase in interest cost = $ 47343
{15,600,000 x 52/365 x 15% - 12,000,000 x 58/365 x 15%} {This increase is due to increase in sales and not due to reduction in Average Credit Period. Reduction in average credit period infact reduces the interest cost}
Increase in Discount Cost = $ 256,200
{15,600,000 x 65% x 3% - 12,000,000 x 20% x 2%}
Increase in Bad Debts = $ 211,200
{15,600,000 x 4.2% - 12,000,000 x 3.7%}
Total Cost = $514,743
Total Benefits = $4,68,000
Therefore Option d is correct.
No, the difference between marginal benefits and marginal costs is ($46,743)
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