Exhibit 27.3
Van Doren Housing expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days dales outstanding (DSO) is 60 days; and the bad debt loss percentage is 5 percent. Also, Van Doren's cost of capital is 15 percent, and its variable costs total 60 percent of sales. Since Van Doren wants to improve its profitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is, change the credit terms to 2/10, net 30. The consultants predict that sales would increase by $500,000, and that 50 percent of all customers would take the discount. The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 4 percent.
-Refer to Exhibit 27.3.What would be the incremental bad debt losses if the change were made?

Question

Quizplus · Accepted Answer

To calculate incremental bad debt losses, we need to compare the current expected bad debt loss with the expected bad debt loss under the proposed new credit terms.

Under current credit terms: 
Expected bad debt loss = 5% of $15 million = $750,000

Under proposed new credit terms: 
Expected bad debt loss = 4% of ($15.5 million - $500,000*50%) = $520,000

Incremental bad debt losses = $750,000 - $520,000 = $130,000

Therefore, the incremental bad debt losses would decline by $130,000 if the proposed new credit terms were implemented.

Exhibit 27.3 Van Doren Housing Expects to Have Sales This Year of Year