Exhibit Van Doren
Van Doren Housing expects to have sales this year of $15 million under its current credit policy.The present terms are net 30; the days dales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent.Also, Van Doren's cost of capital is 15 percent, and its variable costs total 60 percent of sales.Since Van Doren wants to improve its profitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is, change the credit terms to 2/10, net 30.The consultants predict that sales would increase by $500,000, and that 50 percent of all customers would take the discount.The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 4 percent.
-Refer to Exhibit Van Doren.What would be the incremental bad debt losses if the change were made?

Question

Quizplus · Accepted Answer

Under the current credit policy, bad debt losses are 5% of sales, which equals $750,000 ($15,000,000 x 0.05).

If the credit terms are changed to 2/10, net 30, and bad debt losses fall to 4% of sales, the incremental bad debt losses can be calculated as follows:

Incremental bad debt losses = (New sales x New bad debt loss rate) - (Current sales x Current bad debt loss rate)
= (($15,500,000 x 0.04) - ($15,000,000 x 0.05))
= ($620,000 - $750,000)
= -$130,000

Therefore, bad debt losses would decline by $130,000 if the credit terms are changed to 2/10, net 30.

Exhibit Van Doren Van Doren Housing Expects to Have Sales This Year of This