Terry's Place is currently experiencing a bad debt ratio of 4%. Terry is convinced that, with looser credit controls, this ratio will increase to 8%; however, she expects sales to increase by 10% as a result. The cost of goods sold is 80% of the selling price. Per $100 of current sales, what is Terry's expected profit under the proposed credit standards?

Question

Quizplus · Accepted Answer

First, let’s calculate Terry's profit per $100 of current sales with the current bad debt ratio of 4%.

The 4% bad debt ratio means that 4% of sales will be uncollectible, which can be considered a cost to Terry’s business. So, Terry’s net profit per $100 of sales is:

Net profit = Selling price – (Cost of goods sold + Bad debt)

Net profit = $100 – (0.8 x $100 + 0.04 x $100) = $100 – $84 = $16

Now let’s calculate Terry’s expected profit per $100 of sales with the proposed credit standards.

With the proposed credit standards, Terry expects the bad debt ratio to increase to 8%. So, Terry’s net profit per $100 of sales with the proposed credit standards is:

Net profit = Selling price – (Cost of goods sold + Bad debt)

Net profit = $110 – (0.8 x $110 + 0.08 x $110) = $110 – $93.6 = $16.4

Therefore, the expected profit per $100 of sales under the proposed credit standards is $16.4, and to find the total expected profit under the proposed credit standards, we can calculate:

Expected profit = ($16.4 / $100) x Total sales

Expected profit = ($16.4 / $100) x $10,000 = $1,640

However, the question asks for the expected profit per $100 of current sales, not per $100 of total sales. So, we need to adjust our calculation accordingly:

Expected profit per $100 of current sales = Expected profit / (Total sales / Current sales)

Expected profit per $100 of current sales = $1,640 / ($10,000 / $8,000) = $1,640 / 1.25 = $1,312

Therefore, the expected profit per $100 of current sales under the proposed credit standards is $1,312, which is $3.60 lower than Terry’s current profit per $100 of sales.

So, the best choice is C, $13.2.

Terry's Place Is Currently Experiencing a Bad Debt Ratio of 4