Universal Corporation is concerned about their current bad debt ratio of 6%.The CFO believes imposing a more stringent credit policy may reduce sales by 5% and reduce the bad debt ratio to 4%.If the cost of goods sold is 80% of the selling price, determine if the new policy should be undertaken.
A)Undertake; increase of 8.57% in profits
B)Undertake; increase of 9.55% in profits
C)Do not undertake; decrease of 8.57% in profits
D)Do not undertake; decrease of 9.55% in profits

Question

Quizplus · Accepted Answer

Under the current policy, for every $100 in sales, the cost of goods sold (COGS) is $80, leaving a gross profit of $20. However, with a bad debt ratio of 6%, the actual profit is reduced by $6 (6% of $100), leaving a net profit of $14. Under the new policy, sales would decrease to $95, and with a COGS of 80%, the gross profit on these sales would be $19. The bad debt ratio would also decrease to 4%, reducing the profit by $3.8 (4% of $95), leaving a net profit of $15.2. The increase in profit from $14 to $15.2 represents an increase of $1.2 on the original $14, which is an increase of approximately 8.57%.

Universal Corporation Is Concerned About Their Current Bad Debt Ratio