Question

The Boyd Corporation has annual credit sales of $1.95 million. Current expenses for the collection department are $31,000, bad-debt losses are 1.7%, and the days sales outstanding is 30 days. The firm is considering easing its collection efforts such that collection expenses will be reduced to $25,000 per year. The change is expected to increase bad-debt losses to 2.7% and to increase the days sales outstanding to 45 days. In addition, sales are expected to increase to $1,975,000 per year. Suppose that the opportunity cost of funds is 19%, the variable cost ratio is 80%, and taxes are 40%. Assuming a 365-day year, calculate the cost of carrying receivables under the current policy and the new policy. Enter your answers as positive values. Do not round intermediate calculations. Round your answers to the nearest dollar. Current policy: $ New policy: $ Should the firm relax collection efforts?

Answer 1

		Current Policy	New Policy
1)	Sales	$ 19,50,000	$19,75,000
	Contribution margin at (100%-80% = 20%)	$    3,90,000	$   3,95,000
	Increase in contribution margin [1]			$            5,000
2)	Receivables:
	= 1950000*30/365 =	$    1,60,274
	= 1975000*45/365 =		$   2,43,493
	Investment in receivables at 80%	$    1,28,219	$   1,94,795
	Increase in investment		$      66,575
	Cost of carrying receivables at 19% [2]			$         12,649
3)	Collection costs	$       31,000	$      25,000	$            6,000
4)	Bad debts expense	$       33,150	$      53,325
	Increase in bad debts [3]			$         20,175
5)	Incremental pretax income = [1]+[3]-[2]-[4]			$        -21,824
6)	Tax at 40%			$          -8,730
	After tax incremental loss			$        -13,095
6)	The firm should not introduce the new policy as it would result in incremental pretax loss of $21,824 &
	incremental after tax loss of $13,095.