Bluegrass Distilleries, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them. This policy results in lost sales of $10 million annually. Based on experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6%. The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20. Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20%. When converting from annual to daily or vice versa, assume there are 365 days per year. If Bluegrass Distilleries extends credit to these (previously delinquent) customers, determine the increase in the investment in receivables.

Question

Quizplus · Accepted Answer

The increase in the investment in receivables can be calculated using the formula for the average investment in receivables, which is (Annual Sales × Average Collection Period / 365) × (1 - Bad Debt Loss Ratio). Given the annual lost sales of $10 million, an average collection period of 90 days, and a bad-debt loss ratio of 6%, the calculation is ($10,000,000 × 90 / 365) × (1 - 0.06) = $2,465,753.