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Unformatted text preview: also the profit contribution per unit (in this case $4)
that is included in the “additional profit contribution from sales.” Thus the
resulting cost of marginal bad debts is $6,600.
Making the Credit Standard Decision To decide whether to relax its credit
standards, the firm must compare the additional profit contribution from sales to
the added costs of the marginal investment in accounts receivable and marginal
bad debts. If the additional profit contribution is greater than marginal costs,
credit standards should be relaxed.
EXAMPLE The results and key calculations related to Dodd Tool’s decision whether to relax
its credit standards are summarized in Table 14.2. The net addition to total profits resulting from such an action will be $2,812 per year. Therefore, the firm
should relax its credits standards as proposed.
The procedure described here for evaluating a proposed change in credit
standards is also commonly used to evaluate other changes in the management of
accounts receivable. If Dodd Tool had been contemplating tightening its credit
standards, for example, the cost would have been a reduction in the profit contri- CHAPTER 14 TABLE 14.2 Working Capital and Current Assets Management 615 The Effects on Dodd Tool of a Relaxation of
Credit Standards Additional profit contribution from sales
[3,000 units ($10 $6)] Cost of marginal investment in $12,000
A/Ra Average investment under proposed plan:
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