FM27 25 - The brothers believe that the discount would both...

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Mini Case: 27 - 25 i. Assume now that it is several years later. The brothers are concerned about the firm's current credit terms, which are now net 30, which means that contractors buying building products from the firm are not offered a discount, and they are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80 percent (by dollar volume) of the firm's paying customers generally pay the full amount on day 30, while the other 20 percent pay, on average, on day 40. Two percent of the firm's gross sales end up as bad debt losses. The brothers are now considering a change in the firm's credit policy. The change would entail (1) changing the credit terms to 2/10, net 20, (2) employing stricter credit standards before granting credit, and (3) enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2 percent discount, but all others would have to pay the full amount after only 20 days.
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Unformatted text preview: The brothers believe that the discount would both attract additional customers and encourage some existing customers to purchase more from the firm--after all, the discount amounts to a price reduction. Of course, these customers would take the discount and, hence, would pay in only 10 days. The net expected result is for sales to increase to $1,100,000; for 60 percent of the paying customers to take the discount and pay on the 10th day; for 30 percent to pay the full amount on day 20; for 10 percent to pay late on day 30; and for bad debt losses to fall from 2 percent to 1 percent of gross sales. The firm's operating cost ratio will remain unchanged at 75 percent, and its cost of carrying receivables will remain unchanged at 12 percent. To begin the analysis, describe the four variables that make up a firm's credit policy, and explain how each of them affects sales and collections. Then use the information given in part H to answer parts I through N....
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