Question

Saccomanno Industries Inc. is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them. Current annual credit sales are $10 million on credit terms of "net 30". Such a change in policy is expected to reduce sales by 10 percent, cut the firm's bad-debt losses from 5 to 3 percent, and reduce its average collection period from 72 days to 45 days. The firm's variable cost ratio is 0.70 (profit contribution ratio is 0.30) and its pretax return (i.e. opportunity cost) on receivables investments is 12%. Determine the net effect of this credit tightening policy on the pretax profits of Saccomanno Industries Inc. When converting from annual to daily data or vice versa, assume that there are 365 days per year.

Answer 1

1)	Loss of contribution margin on decrease of sale = 10000000*10%*30% =		$    -3,00,000
2)	Existing bad debts = 10000000*5% =	$       5,00,000
	Revised bad debts = 9000000*3% =	$       2,70,000
	Savings in bad debts		$      2,30,000
3)	Existing investment in receivables = 10000000*70%*72/365 =	$     13,80,822
	Revised investment in receivables = 9000000*70%*45/365 =	$       7,76,712
	Decrease in investment in receivables	$       6,04,110
	Opportunity cost on decrease in investment in receivables = 604110*12% =		$         72,493
	Increase in pretax profits		$            2,493