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Question - East Lansing Appliances (ELA) expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Since ELA wants to improve its profitability, the treasurer has proposed that the credit period be shortened to 15 days. This change would reduce expected sales to $14,500,000, but it would also shorten the DSO on the sales to 30 days. Expected bad debt losses on the sales would fall to 3 percent. The variable cost percentage is 60 percent, and the cost of capital is 15 percent. The tax rate is 40%. Assume 360 days a year.
Required -
1. What would be the bad losses before and after the change were made?
2. What would be the cost of carrying receivables before and after this change were made?
3. What are the pre-tax profits before and after this proposal?
4. What are the after-tax profits before and after this proposal?
5. What would be your recommendation on this new proposal?
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