Dizzy Animators, Inc. currently makes all sales on credit and offers no cash discount. The firm is considering a 3 percent cash discount for payment within 10 days. The firm's current average collection period is 90 days, sales are 400 films per year, selling price is $25,000 per film, variable cost per film is $18,750 per film, and the average cost per film is $21,000. The firm expects that the change in credit terms will result in a minor increase in sales of 10 films per year, that 75 percent of the sales will take the discount, and the average collection period will drop to 30 days. The firm's bad debt expense is expected to become negligible under the proposed plan. The bad debt expense is currently 0.5 percent of sales. The firm's required return on equal-risk investments is 20 percent.
-What is the marginal investment in accounts receivable under the proposed plan?
A) $1,382,500
B) $1,234,375
C) $1,567,300
D) $1,841,570

Question

Quizplus · Accepted Answer

The marginal investment in accounts receivable is calculated by comparing the average accounts receivable before and after the change in credit terms. The average accounts receivable is calculated as (Sales/365) * Average Collection Period. Under the current plan, the average accounts receivable is (400 * $25,000 / 365) * 90. Under the proposed plan, it is ((410 * $25,000 * 0.75 * 0.97 + 410 * $25,000 * 0.25) / 365) * 30. The difference between these two values gives the marginal investment in accounts receivable.