Saskatchewan Potash Ltd. has $20 million in credit sales per year and on average they are outstanding for 55 days. Potash sells for $1,000 per ton and results in a 20% contribution margin. Receivables are financed at a 10% interest rate. Bad debts total $600,000 annually. The accounting department has a new plan by which it estimates it can eliminate three-quarters of the bad debts and reduce the collection period by 25 days if it is permitted to hire one collections specialists at a cost of $105,000 per year. Some sales would be lost due to credit tightening under the new plan. By what percentage would sales have to decline to leave Saskatchewan Potash Ltd. indifferent between the two alternatives.?

Question

Quizplus · Accepted Answer

The savings from reducing bad debts and interest costs must equal the loss in contribution margin from reduced sales. Calculate the savings from reduced bad debts and interest, then find the percentage decline in sales that results in an equivalent loss in contribution margin.