Table 14.5
Caren's Canoes is considering relaxing its credit standards to encourage more sales. As a result, sales are expected to increase 15 percent from 300 canoes per year to 345 canoes per year. The average collection period is expected to increase to 40 days from 30 days and bad debts are expected to double the current 1 percent level. The price per canoe is $850, the variable cost per canoe is $650 and the average cost per unit at the 300 unit level is $700. The firm's required return on investment is 20 percent. (Assume a 360-day year)
-What is the cost of marginal bad debts under the proposed plan? (See Table 14.5)
A) $383
B) $765
C) $3,315
D) $5,100

Question

Quizplus · Accepted Answer

Using Table 14.5, we can calculate the cost of marginal bad debts as:

Cost of marginal bad debts = (Increase in bad debts as a percentage of sales) x (Increase in sales) x (Price per unit - Variable cost per unit)

Increase in bad debts as a percentage of sales = (2% - 1%) / 1% = 1%

Increase in sales = 345 - 300 = 45 canoes

Price per unit - Variable cost per unit = $850 - $650 = $200

Cost of marginal bad debts = 1% x 45 x $200 = $9,000

However, since the question asks for the cost of marginal bad debts, we need to subtract the bad debts that would have been incurred at the current sales level:

Bad debts at current sales level = 1% x 300 x $200 = $6,000

Therefore, the cost of marginal bad debts under the proposed plan is $9,000 - $6,000 = $3,000

This is option C.

Table 14.5 Caren's Canoes Is Considering Relaxing Its Credit Standards to Encourage