Maggie’s Gold Coins, Inc is considering shortening its credit period f

Maggie’s Gold Coins, Inc is considering shortening its credit period from 30 days to 20 days and believes, as a result of this change, its average collection period will decrease from 36 days to 30 days.

Bad debt expenses are also expected to decrease from 1.2 percent to 0.8 percent of sales. The firm is currently selling 300,000 units but believes as a result of the change, sales will decline to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total $3,300,000, and fixed costs are $300,000. The firm has a required return on similar-risk investments of 15 percent. Evaluate this proposed change and make a recommendation to the firm.

ANSWER

300,000 – 275,000 = 25,000 units decline in sales
Price = P = $4,200,000/300,000 = $14
Variable cost per unit = v = $3,300,000/300,000 = $11
Reduction in profit contribution from decline in sales
= (300,000 – 275,000 units) × ($14 – $11 ) = $75,000
Cost of marginal investment in A/R:
Turnover of A/R with proposed plan = 360/30 = 12
Average investment with proposed plan = = $252,083
Turnover of A/R with present plan = 360/36 = 10
Average investment with present plan = = $330,000
Reduced investment in A/R = $ 77,917
Reduction in cost of marginal investment in A/R = 77,917 × (0.15 ) = $11,688
Reduction in marginal bad debts:
Bad debts with present plan = (0.012 ) ×($4,200,000 ) = $50,400
Bad debts with proposed plan = (0.008 ) × ($275,000 ) × (14 ) = $30,800
Reduction in bad debts = $19,600
Net loss from implementing proposed plan = -$75,000 + $11,688 + $19,600 = -$43,712
This proposal is not recommended.