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 are the incremental pre-tax profits from this proposal?

Question

Quizplus · Accepted Answer

The incremental pre-tax profits are calculated by considering the increase in sales, reduction in bad debt losses, cost of offering the discount, and the change in carrying costs due to the change in DSO. The increase in sales is $500,000, with a contribution margin of 40% (since variable costs are 60%), resulting in $200,000. The reduction in bad debt losses is 1% of the new sales ($15.5 million), which is $155,000. The cost of the discount is 2% of 50% of the new sales, which is $155,000. The change in carrying costs is calculated using the cost of capital and the change in DSO, resulting in a saving of $83,750. Adding these components gives the incremental pre-tax profit of $283,750.

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