Question

3. In order to increase sales from their present annual $35 million, ABC Company, a retailer, is considering more liberal credit standards. Currently, the firm has an average collection period of 30 days. It believes that with increasingly liberal credit standards, the following will result:
Credit Policy
A   B C D
Increase in sales from previous level (in millions) $6.2 $4.6 $2.6 $1.2
Average collection period for incremental sales (days) 45 60 90 150
Bad-debt losses on incremental sales 2% 3% 5% 8%
The prices of its products average $30 per unit, and variable costs average $26 per unit. If the company has a before-tax opportunity cost of 20%, which credit policy should be pursued?

Answer 1

Answer:

Credit policy A should be pursued

Net Incremental benefit is maximum if credit policy A is pursued.

Workings:

Average price per unit =$30

Average variable cost per unit = $26

Contribution margin % = (30 - 26) / 30 = 13.3333%

Incremental benefit, incremental cost and net incremental benefit calculations: