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 $4.34 million annually to $5.58 million with credit terms of 1/10, net 30. Furthermore, research estimates that 85 percent of the customers would take the discount and the remainder would pay on average on the 30th day. Inventory turnover would remain at 13 times a year. Cost of goods sold (variable costs) are 75 percent of gross sales. Bad debts are estimated to be 0.75 percent of credit sales. Credit department expenses would be $50,800 per year plus the salary of 2 individuals at $35,800 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 4 percent of gross sales. Bank financing of working capital requirements is at 11 percent.

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 and the values to be deducted should be indicated by a minus sign. Enter answers in whole dollar, not in million. Do not round intermediate calculation.)

A Contribution margin A Discount expense Present policy New policy A Bad debt expense Present policy New policy A Marketing expense Present policy New policy A Administrative expense (related to credit department) Present policy New policy A Investment in accounts receivable Present policy New policy 85% of the customers 15% of the customers A Opportunity benefit on investment in A/R A Investment in inventory Present policy New policy A Opportunity benefit on inv. investment Total incremental change

Thanks!

Answer 1

Statement showing different calculation

Particular	Old scheme	new scheme	Changes
Sales	4340000	5580000
Less: Variable cost@ 75%	3255000	4185000
Contribution margin	1085000	1395000	310000
$\bigtriangleup$Bad debt Expenses	0	=0.75% of 5.58 m=41850	(41850)
$\bigtriangleup$Marketing Expenses@ 4% of sales	173600	223200	(49600)
$\bigtriangleup$Administration expenses	35800	50800+71600=122400	(86600)
$\bigtriangleup$Investment in account receivable
85% of the customer *10/365	0	129945
15% of the customer*75%*30/365	0	68795
$\bigtriangleup$Opportunity benefit on investment in A/R(Note 1)	0	2.1%	(4174)
$\bigtriangleup$Investment in inventory (Note 2)	250385	321923
$\bigtriangleup$Opportunity cost on inventory investment	0	0.84%	604
Total incremental Changes			127172

Opportunity benefit on investment in account receivable

Increase in contribution due to credit policy= $310000

(5580000-4340000)*25% = 310000

Less: Bad debt due to credit sales $41850

5580000*0.75%= 41850

Less: Discount offered $47430

(5580000*85%*1%)

Less: Credit department expenses $50800

Less Bank financing charges

5580000*85%*75%*11%*10/365 $10720

5580000*15%*75%*11%*30/365 $5676

Less: Salary of 1 staff $35800

Less: cost of additional investment in inventory(note 3) $604

Opportunity benefit   $117120

Opportunity benefit on account receivable %

= 112260/5580000*100 = 2.1%

Note 2

Inventory turnover ratio = Cost of goods sold/Avg inventory

Present policy = 4340000*75%/Avg inventory=13 times

Avg Inventory = 3255000/13

= $250385

New Policy = 5580000*75%/avg inventory= 13times

= Avg Inventory = 4185000/13 = $321923

note 3 Opportunity Benefit on inventory investment =

Increase in inventory (321923-250385) =71538

No of day of inventory handling = 365 day/Inventory turnover ratio

= 365/13 = 28 day

Opportunity cost = 71538*11%*28/365

= $604

% = $604/71538*100 = 0.84%