Question

Nike is considering changing its credit terms from “net 60” to “net 30” in its western Ohio sales territory. The company expects sales (all on credit) to decrease by 10% from a current level of 4 million, and it expects its average collection period to decrease from 70 days to 38 days. The bad-debt ratio should decline to 2.5% of sales from a current level of 5% of sales. The company also estimates that inventory investment would decrease by $100,000 for the expected sales decrease. The company’s variable cost ratio is 0.55. Nike’s required pretax rate of return on investments in receivables and inventories is 20%. Should Nike proceed with the change from the perspective of pretax profits?

Answer 1

Nike is considering changing its credit term from "net 60" to "net 30" evaluation whether Nike should go with new term or not                                                   (amount in $)

Current sale	4000000
Decrease in sale 10% due to new term (4*10%)	400000
New sale	3600000
Receivable under current term 70 days (4*70/*365)	767123
Receivable under new term 38days (3.6*38/365)	374795
Net decrease in receivable	392329
Cost involved in debtor ( 392329*55%) cost of sale /veriable cost	215781
Saving in intrest cost of receivable (215781*20%)	43156
Saving in interest on reduction of inventory (100000*20%)	20000
Total savings of interest cost due to new term	63156
Current bed debt (4000000*5%)	200000
Bed debt under new term (360000*2.5%)	90000
Saving in bed debt (200000-90000)	110000
Saving in bed debt	110000
Saving in interest cost	63156
Total savings	173156
Less - loss of profit due to decrease in sale (400000*45%)	180000
Net loss due to new term	6844

So due to new term there is loss of $ 6844 so Nike should continue existing term and should not go for new term.

*My assumption is 365 day in year answer slightly change if u assume 360 day in year