Tom's Toys is currently experiencing a bad debt ratio of 6 percent. Tom is convinced that, with tighter credit controls, he can reduce this ratio to 2 percent; however, he expects sales to drop by 8 percent as a result. The cost of goods sold is 75 percent of the selling price. Per $100 of current sales, what is Tom's expected profit under the proposed credit standards?

Question

Quizplus · Accepted Answer

Under the current standards, for every $100 in sales, the cost of goods sold is $75, leaving a gross profit of $25. With a bad debt ratio of 6%, the net profit is reduced by $6 (6% of $100), leaving $19. If sales drop by 8% under tighter credit controls, sales would be $92. The bad debt ratio would also drop to 2%, reducing the net profit by $1.84 (2% of $92). The cost of goods sold would be 75% of $92, which is $69. Therefore, the gross profit would be $92 - $69 = $23. Subtracting the bad debt of $1.84 from $23 gives a net profit of $21.16, which rounds to $21.20.

Tom's Toys Is Currently Experiencing a Bad Debt Ratio of 6