The United Shoe Company (USC) does not extend credit to any retail shoe store with a "Fair" or "Limited" Dun and Bradstreet credit rating.As a result of this policy the company loses $36,500,000 in sales each year.Based on prior experience with these types of customers, USC estimates that the average collection period would be 120 days and the bad-debt loss ratio would be 10%.The firm's variable cost ratio is 0.75.USC's required pretax return on receivables investments is 18%.Determine the net change in pretax profits of extending credit to these retail shoe stores.(Assume 365 days per year in any calculations.)
A)$9,125,000
B)$3,315,000
C)-$1,095,000
D)$2,160,000

Question

Quizplus · Accepted Answer

Additional sales = $36,500,000
Marginal profitability of additional sales = 0.25 × $36,500,000 = $9,125,000
Additional investment in receivables = ($36,500,000/365) × 120 = $12,000,000
Cost of additional investment in receivables = $12,000,000 × 0.18 = $2,160,000
Additional bad­debt loss = 0.10 × $36,500,000 = $3,650,000
Net change in pretax profits = $9,125,000 - $2,160,000 - $3,650,000 = $3,315,000

The United Shoe Company (USC) Does Not Extend Credit to Any