Upon reflection, Kim Chi Company has estimated that the following pattern of bad debt losses will prevail if it initiates more liberal credit terms:
|
|
CREDIT POLICY |
|||
|
A |
B |
C |
D |
|
|
Bad debt losses on incremental sales
|
3% |
6% |
10% |
15% |
Given the other assumptions in the Problem , which credit policy should be pursued? Why?
Problem:
To increase sales from their present annual $24 million, Kim Chi Company, a wholesaler, may try more liberal credit standards. Currently, the firm has an average collection period of 30 days. It believes that, with increasingly liberal credit standards, the following will result:
|
|
CREDIT POLICY |
|||
|
A |
B |
C |
D |
|
|
Increase in sales from previous level (in millions) |
$2.8 |
$1.8 |
$1.2 |
$.6 |
|
Average collection period for incremental sales (days) |
45 |
60 |
90 |
144 |
The prices of its products average $20 per unit, and variable costs average $18 per unit. No bad debt losses are expected. If the company has a pre tax opportunity cost of funds of 30 percent, which credit policy should be pursued? Why? (Assume a 360 day year.)