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Acme Batteries currently offers credit terms of 2/10, n30, and Sarah, the vice president for
marketing, thinks the terms should be changed to 2/10, n40. Doing so, she says, will result in a
10% increase in sales, but only a small increase in bad debts. Should Acme make the change?
For the sake of simplicity, following assumptions are considered:
Ms. Sarah is correct that sales will increase by 10% if the new credit policy is
implemented.
Cost of goods sold and other operating expenses on the firms income statement, and all
current accounts on the balance sheet, will vary directly with sales. So each of these
accounts will increase by 10% with the change in credit policy.
All of Acmes sales are made on credit.
Suppose further that Ms. Sarah produced the following data on Acmes customers historical
payments:
45% of customers take advantage of the discount and pay off their accounts in 10 days.
53% of customers forgo the discount, but pay off their accounts in 30 days.
The remaining 2% of customers pay off their accounts in 100 days.
Ms. Sarah expects that under the new credit policy (2/10, n40):
45% of customers will take advantage of the discount and pay off their accounts in 10
days.
52% of customers will forgo the discount, but pay off their accounts in 30 days.
The remaining 3% of customers will pay off their accounts in 100 days.
Acmes CFO has informed that any increases in current assets resulting from the policy change
will be financed from short-term notes at an interest rate of 6%. He has also informed that the
firms effective tax rate is 40%, and that the cost of capital is 10%. The long-term interest rate is
8%. You are required to tell Ms. Sarah whether the new credit policy is worth accepting or not.
Following data from the income statement and balance sheet are given.
Sales
CGS
Gross Profit
Bad Debt Expenses
Other Operating Expenses
Operating Income
Interest Expense
EBT
Income Tax
Net Income
43229
$65313
21453
92983
26186
302
15034
35000
32100
83507
150607
You are required to tell Dan whether the new inventory policy is worth accepting or not.
Following data from the income statement and balance sheet are given.
Current Inventory Policy
Sales
CGS
Gross Profit
Inventory Costs
Other Operating Expenses
Operating Income
Interest Expense
EBT
Income Tax
Net Income
85000
47000
63000
72000
50000
74000
124000
45000
169000
35000
34000
104000
173000