Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your answer is an original. Do not submit as is
Relaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to 11,000 units during the coming year; the average collection period is expected to increase from 45 to 60 days; and bad debts are expected to increase from 1% to 3% of sales. The sale price per unit is $40, and the variable cost per unit is $31. The firm’s required return on equal-risk investments is 25%. Evaluate the proposed relaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)
Additional profit contribution from sales = 1,000 additional units ´ ($40 - $31) $9,000
Cost of marginal investment in A/R:
Average investment, proposed plan = $56,055
Average investment, present plan = 38,219
Marginal investment in A/R $17,836
Required return on investment ´ 0.25
Cost of marginal investment in A/R (4,459)
Cost of marginal bad debts:
Bad debts, proposed plan (0.03 ´ $40 ´ 11,000 units) $13,200
Bad debts, present plan (0.01 ´ $40 ´ 10,000 units) 4,000
Cost of marginal bad debts (9,200)
Net loss from implementing proposed plan ($4,659)
The credit standards should not be relaxed since the proposed plan results in a loss.
ETHICS PROBLEM Controlled disbursing is defined as an information product—that is, the bank on which the company’s checks are drawn provides an early-morning notification of the total dollar amount of checks that will clear the account that day. Based on that notification, the company may then fund the account for that amount by the close of business that afternoon. How might controlled disbursing still be viewed as a form of “remote disbursing,” and therefore be considered unethical?
Controlled disbursement accounts located at banks very distant from the company’s payables staff, headquarters, and other offices are suspect. This really puts it into the realm of “remote disbursement,” especially when the account is located in an out-of-the-way locale such as Grand Junction, CO (which is where one bank’s controlled disbursement accounts are located). It takes the Fed longer to present checks to this remote location.