Reference no: EM133010349

Question - Mr. Walker, a credit manager of a company, discovered that the industry-wide credit terms are net 60 days, while his firm sells on credit terms of net 90 days. Current sales are $5 million per year. The company currently averages 105 days of sales in accounts receivable.

Walker estimates that tightening terms to the industry average of 60 days will reduce annual sales to $4 million but that accounts receivable will drop to 70 days of sales and the bad debt ratio will drop from 3% to 1% of sales. The company has a variable cost ratio of 75%, and its cost of funds is 12% on its line of credit.

Current Policy Proposed Policy

Sales $5 M $4 M

Terms 90 days 60 days

Bad debts 3% 1%

Which of the following statements is true about the calculations you should perform when comparing the NPV's of the current and proposed policies?

a) For the proposed policy, the PV of receipts on only the collectable sales are discounted back the allowed 60 days as part of the NPV calculation

b) For the current policy, the PV of the receipts on sales involves discounting all sales revenue based on the 90 days allowed for payment as part of the NPV calculation

c) For the proposed policy, the PV of the receipts involves discounting only the collectable 99 cents on the dollar of sales based on the 90 days allowed for payment

d) None of the other choices is true

e) For the current policy, the variable costs of production are subtracted only for the 97 cents on the dollar of sales that are actually collected