Little Runabout Inc.makes small trailers for light-duty towing behind SUVs and small pickup trucks.Its trailers typically sell for $2,500.Many of its customers have asked for credit terms to aid in purchasing the trailers.The firm's finance department has estimated the following profile for its light-duty trailers and customer base: $\begin{array}{ll}
\text { Annual sales: } & 10,000 \text { trailers } \
\text { Annual production costs per trailer: } & \$ 1,500 \
\text { Lost sales if credit is not provided for customers: } & 2,000 \text { trailers } \
\text { Default rate if all customers purchase on credit: } & 3.00 \%
\end{array}$ What is the change in the profit if the firm moves from a cash-only policy to a credit policy?
A)$1,250,000
B)$8,000,000
C)$9,250,000
D)$15,000,000

Question

Quizplus · Accepted Answer

Under the cash-only policy, the profit is calculated as follows: $$ \text{Profit} = (\text{Selling Price} - \text{Cost per Trailer}) \times \text{Annual Sales} $$$$ \text{Profit} = (\$2,500 - \$1,500) \times 10,000 = \$1,000 \times 10,000 = \$10,000,000 $$Under the credit policy, the sales increase to 10,000 trailers (since the lost sales of 2,000 trailers are recovered), but there's a default rate of 3%. Therefore, the effective sales are 97% of 10,000 trailers:$$ \text{Effective Sales} = 10,000 \times 97\% = 9,700 $$The profit under the credit policy is:$$ \text{Profit} = (\$2,500 - \$1,500) \times 9,700 = \$1,000 \times 9,700 = \$9,700,000 $$The change in profit moving from a cash-only policy to a credit policy is:$$ \text{Change in Profit} = \$9,700,000 - \$10,000,000 = -\$300,000 $$However, the calculation above does not account for the additional sales revenue from the 2,000 trailers that would have been lost sales under the cash-only policy. To accurately calculate the change in profit, we need to consider the additional profit from these sales:$$ \text{Additional Profit from Sales} = (\$2,500 - \$1,500) \times 2,000 = \$1,000 \times 2,000 = \$2,000,000 $$Therefore, the corrected change in profit, considering the additional sales, is:$$ \text{Corrected Change in Profit} = -\$300,000 + \$2,000,000 = \$1,700,000 $$It seems there was a mistake in the calculation that led to the incorrect conclusion. The correct approach to calculate the change in profit should consider both the impact of defaults and the additional sales revenue from offering credit. Let's re-evaluate the calculation:Under the credit policy, the total revenue (without considering defaults) from selling 10,000 trailers (recovering the 2,000 lost sales) at $2,500 each is:$$ \text{Total Revenue} = 10,000 \times \$2,500 = \$25,000,000 $$The total cost is:$$ \text{Total Cost} = 10,000 \times \$1,500 = \$15,000,000 $$So, the profit before defaults is:$$ \text{Profit before defaults} = \$25,000,000 - \$15,000,000 = \$10,000,000 $$Considering the default rate of 3% on the total revenue:$$ \text{Defaults} = \$25,000,000 \times 3\% = \$750,000 $$The profit after accounting for defaults is:$$ \text{Profit after defaults} = \$10,000,000 - \$750,000 = \$9,250,000 $$The change in profit, therefore, from moving to a credit policy is the difference between the profit after defaults and the original profit under the cash-only policy:$$ \text{Change in Profit} = \$9,250,000 - \$10,000,000 = -\$750,000 $$This indicates a mistake in the initial response, as none of the provided options or calculations accurately reflect the correct change in profit based on the given data and the correct approach to calculating it. The correct calculation should consider the impact of defaults on the additional revenue generated by offering credit, which was not properly accounted for in the initial response. Given the provided options and the mistake in the calculation, the correct answer should reflect the profit change due to offering credit, considering both the recovered lost sales and the impact of defaults, which was not accurately captured in the provided options or explanation.

Little Runabout Inc What Is the Change in the Profit If the Firm