Question

OB1 Sabres Ltd. has determined that product sales are not what they could be because they have unused capacity. As a result, the company is considering adjusting its marketing strategy. At present, all sales to distributors are on a cash basis, but the competition offers credit terms. Similar credit terms for OB1 Sabres have been suggested. Research suggests that sales in the upcoming year would jump from $4,370,000 annually to $5,640,000 with credit terms of 1/10, net 30. Furthermore, research estimates that 85 percent of the customers would take the discount and the remainder would pay on average on the 30th day. Inventory turnover would remain at 13 times a year. Cost of goods sold (variable costs) are 75 percent of gross sales. Bad debts are estimated to be .75 percent of credit sales. Credit department expenses would be $51,400 per year plus the salary of 2 individuals at S36,400 per year each. One of the staff would be reassigned from another division without affecting costs or productivity as that individual is currently redundant in that division. Marketing expenses are 4 percent of gross sales. Bank financing of working capital requirements is at 11 percent.

    

a.	Should OB1 Sabres Ltd. adopt the proposed policy?
	No Yes

  

b.	Show the calculations. (Use 365 days in a year. Do not leave any empty spaces; input a "0" wherever required. Round the answers to the nearest whole dollar. Negative answers should be indicated by a minus sign.)

   

? Sales
Present policy	$
New policy
	$
? Contribution margin	%	$
? Discount expense
Present policy no discount	$
New policy
	$
? Bad debt expense
Present policy	$
New policy
	$
? Marketing expense
Present policy	$
New policy
	$
? Administrative expense (related to credit       department)
Present policy	$
New policy	$
	$
? Investment in accounts receivable
Present policy	$
New policy
	$
? Opportunity benefit on investment in A/R	%	$
? Investment in inventory
Present policy	$
New policy
	$
? Opportunity benefit on inv. investment	%
Total incremental change		$

Answer 1

a) No.OB1 Sabres Ltd. should not adopt the proposed policy.

b)Calculation are shown below:

Particulars	Amt. in $	Amt. in $
? Sales
Present policy	4370000
New policy	5640000
	1270000
? Contribution margin(100-75)% (X)	0.25	317500
Less:
? Discount expense
Present policy no discount	0
New policy (5640000*85%*1%)	47940
(A)	47940
? Bad debt expense
Present policy	0
New policy (5640000*.75%)	42300
(B)	42300
? Marketing expense
Present policy (4370000*4%)	174800
New policy (5640000*4%)	225600
(C)	50800
? Administrative expense (related to credit department)
Present policy	0
New policy (51400 + 36400*2)	124200
(D)	124200
Expense(A+B+C+D) =(E)		265240
? Investment in accounts receivable
Present policy	0
New policy (5640000*30/365)	463561.64
	463561.64
? Opportunity benefit on investment in A/R (463561*11%)=(F)	0.11	50991.78
? Investment in inventory
Present policy(4370000/13)	336153.84
New policy(5640000/13)	433846.15
	97692.31
? Opportunity benefit on inventory investment (G)	0.11	10746.15
Total incremental change(X-E-F-G)		-9477.93

Since total incremental change is negative thus OB1 Sabres Ltd. should not adopt the proposed policy.