East Lansing Appliances (ELA) expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Since ELA wants to improve its profitability, the treasurer has proposed that the credit period be shortened to 15 days. This change would reduce expected sales by $500,000, but it would also shorten the DSO on the remaining sales to 30 days. Expected bad debt losses on the remaining sales would fall to 3 percent. The variable cost percentage is 60 percent, and the cost of capital is 15 percent.
-What would be the incremental cost of carrying receivables if this change were made?
A) $108,750
B) -$116,250 (carrying costs would decline)
C) $157,900
D) -$225,000 (carrying costs would decline)
E) $260,500

Question

Quizplus · Accepted Answer

The incremental cost of carrying receivables is calculated by comparing the carrying costs before and after the change. The reduction in DSO and bad debt losses, along with the decrease in sales, results in a decline in carrying costs.

East Lansing Appliances (ELA) Expects to Have Sales This Year