Question

Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.63 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,505,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit. Assume that Vinson’s variable cost ratio is 80%, taxes are 40%, and the interest rate on funds invested in receivables is 23%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions above. Assuming a 365-day year, calculate the net income under the current policy and the new policy. Do not round intermediate calculations. Round your answers to the nearest dollar. Current policy: ? New policy: ? Should the change in credit terms be made?: The firm should change its credit terms

Answer 1

 

Contribuution Margin is 100%-80% is 20% and tax rate is 40% .These are same for both the policies

Net Benefit from new credit policy is the difference between decrease in the Cost of Receivables and decrease in contribution

Calculation of the Net Income and its changes due to effect of credit policy

Terms

Current 90 days

New 30 days

Change

WN

Sales

$2,630,000

$2,505,000

Calculation of receivables under the current policy

Average Collection Period

95 Days

35 days

Receivables

Sales * Average Collection Period/365

Receivables

$684,521

$240,205

$2630000*95/365

Cost Receivables at 23%

($684251*23%)

($240205*23%)

$684,521

$157,440

$55,247

$102,193

Calculation of receivables under the new policy

(-)Contribution at 20% on sales

($2630000*20%)

($2505000*20%)

$526,000

$501,000

$25,000

Receivables

Sales * Average Collection Period/365

Income Before tax

$77,193

$2505000*35/365

Tax -40%

$30,877.20

$240,205

Net Income after tax

$46,315.80

Since the net income is positive hence the change in credit terms should be made