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 $4,345,000 annually to $5,590,000 with credit terms of 2/10, net 30. Furthermore, research estimates that 80 percent of the customers would take the discount and the remainder would pay on average on the 30th day. Inventory turnover would remain at 15 times a year. Cost of goods sold (variable costs) are 65 percent of gross sales. Bad debts are estimated to be .65 percent of credit sales. Credit department expenses would be $50,900 per year plus the salary of 3 individuals at S35,900 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 5 percent of gross sales. Bank financing of working capital requirements is at 12 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

Answer:

Required calculations:

Variable cost = 65% of sales

Hence contribution margin = 35% of sales

Discount is taken by 80% of credit customers.

Discount is 2% of credit sales and is estimated to taken by 80% of customers = 2% * 80% * $5,590,000 = $89,440

In existing policy, all sales are cash sales, as such there is no bad debt

New Policy, bad debt expenses are = 0.65% of sales = 0.65% * $5,590,000 = $36,335

Marketing expense is 5% of gross sales

Administrative expense for credit department:

Existing policy = $0

New policy = $50,900 + 3 * $35,900 = $158,600

Investment in account receivable:

Existing policy = $0

New policy = 10/365 * $5,590,000 *80% + 30/365 * $5,590,000 * 20% = $214,411

Opportunity benefit = - $214,410.96 * 12% = - $25,729

Investment in Inventory (Inventory turnover =15)

Existing policy = Cost of goods sold / Inventory turnover = ($4,345,000 * 65%)/15 = $ 188,283

New policy = $5,590,000 * 65% /15 = $242.233

Opportunity benefit = ($188,283.33 - $242.233.33) * 12% = - $6,474

Calculations in required format are as below:

Answer a:

YES

Explanation:

OB1 Sabres Ltd. adopt the proposed policy as based on incremental analysis, we get a net incremental benefit of $56,922 (calculations given above)

Answer b:

The calculations are given above as per format required.