Questions On Credit Policy

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1) The four variables that make up a firms credit policy are: Change in profit before Credit Costs
If the sales change or variable costs change and change would also have to occur in profit.
= Change in Sales * (1-VC)

Affects DSO with the change in sales.

Opportunity Cost of Investment in A/R
= (ADS)*(DSO)*(Var Cost Ratio)*(r)
If anything in here changes then the cost of investment in accounts receivable will change. Also changes DSO when one of the variables is changed.

Opportunity Cost of Investment in Inventory
(Change in Sales * COGS %) * (r)
Once again a change in slaes will change the DSO.

Opportunity Cost of Change in Bad Debts
New Bad Debt Expense – Old Bad Debt Expense
More bad debt expense will adversely affect the company’s bottom line. 2) Current DSO .8*30 + .2*40 = 32 Expected DSO .6*10 + .3*20 + .1*30 = 15

3) Current Bad Debt Expenses $1 million * .02 = $20,000 Expected Bad Debt Expected $1.1 million * .01 = $11,000

4) Expected Dollar Cost of Discounts $1.1 million * 99% * 60% * 2% = $13,068

5) Current Cost of Carrying Receivables $1m /360 * 32 * 75% * 12% = $8,000 Expected Cost of Carrying Receivables
$1.1m /360 * 15 * 75% * 12% = $4,125

6) Opportunity Cost of Inventory 1.1m * .75 -1m *.75 = $75,000

7) | Old | New | Sales | 1,000,000 | 1,100,000 | (Discounts) | - | 13,068 | Net Sales | 1,000,000 | 1,086,932 | (CGS) | 750,000 | 825,000 | EBIT | 250,000 | 261,932 | Credit Costs: | | | (Carrying Cost) | 8,000 | 4,125 | (Bad Debt Losses) | 20,000 | 11,000 | Profit Before Tax | 222,000 | 246,807 | (Taxes) 40% | 88,800 | 98,723 | Net Income | 133,200 | 148,084 | | | | Change in NI | 14,884 | |

They should make the change to the new credit system which nets them $14,884 more than the previous system.

8) The credit policy change would decrease risk by offering credit to more trustworthy paying customers

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