Willoughby Industries, Inc.is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them.Current annual credit sales are $10 million on credit terms of "net 30".Such a change in policy is expected to reduce sales by 10 percent, cut the firm's bad-debt losses from 5 to 3 percent, and reduce its average collection period from 72 days to 45 days.The firm's variable cost ratio is 0.70 (profit contribution ratio is 0.30) and its required pretax return (i.e., opportunity cost) on receivables investments is 25 percent.Determine the net effect of this credit tightening policy on the pretax profits of Willoughby.When converting from annual to daily data or vice versa, assume that there are 365 days per year.
A)-$863,014
B)$145,753
C)-$70,000
D)$300,000

Question

Quizplus · Accepted Answer

Reduction in Profit Contribution = $1,000,000 × 0.30 = $300,000
Reduction in A/R = $10,000,000/365 × 72 - $9,000,000/365 × 45 = $863,014
Earnings on Released Funds = $863,014 × 0.25 = $215,753
Decrease in Bad­Debt Losses = $10,000,000 × 0.05 - $9,000,000 × 0.03 = $230,000
Net Change in Pretax Profits = $215,753 + $230,000 - $300,000 = $145,753