Question

E. Credit terms A company is contemplating changing its terms of sale to allow customers to purchase its products on account. a. current level of sales ($15 million) b. current EBIT as a percent of sales (5%) c. current fixed costs ($5 million) d. Determine the percentage variable costs that result in the selected level for EBIT. d. inventory turnover (5) e. expected additional sales (10%) f. expected portion of future sales that remain cash sales despite the change in credit policy (5%) g. expected average time to payment on credit sales (25 days) h. expected portion of credit sales that will be uncollectible (0.5%) i. expected change in fixed costs ($50,000) j expected change in variable costs (1%) k. expected change in inventory turnover (+0.5) 1. cost to carry inventory (8.5%) m. expected cost to carry accounts receivable (5%) 1. How does the company expect its revenue and cost of revenue to change if it makes this change in the terms of sale? 2. How much will the cost to carry inventory change (in $)? 3. What will the average account receivable balance be, and how much will it cost the company in dollars) to carry those accounts receivable be? 4. What will the total losses due to uncollectible accounts be? 5. How is the company's total operating cash flow expected to change with this change in the company's credit policy? 6. How is the company's operating cash flow margin (operating cash flow/total sales) change expected to change with this change in the company's credit policy? 7. Based on your analysis, should the company make this change in its terms of sale? Explain.

Answer 1

Statment showing changes due to change in credit policy

(1) if company decides to change in sales then changes which will happen is shown in below table

as in table it can be seen that change in sale has led to increament of ebit from 5% to 6.72% after all the change in variable cost and fixed cost so the change in sales is benifical for company.

Particulars	Before change($ millions)	after Change($ millions)	Increment/decrease
Sales	15	16.5	10%of 15=1.5 increase
less cost of goods sold:
Fixed cost	-5	-5.05	.05 increase
Variable cost	-9.25 *	-10.34 (16.5of 62.66%)	1% increment
EBIT	0.75( 5% of sales)	1.11 (6.72 of sales)	1.72% increase

* % of variable cost = 9.25/15*100=61.66%

increase in variable cost by 1% =62.66%

(2) before change Inventory Turnover = cost of good sold / average stock

5= fixed cost+ variable cost / average stock

average stock=14.25/5

average stock =$2.85million

so carring cost of inventory = $2.85*8.5%

= $ 0.24 million

and after change inventory Turnover = cost of good sold / average stock

5.5=(5.05+10.34)/ average stock

=15.39/5.5

average stock =$2.80 mill

So carring cost =$2.80*8.5%

=$ 0.238 million

(3)

particulars	before	after
sales	15	16.5
cash sales 5% of sales	0.75	0.825
credit sales 95%	14.25	15.675
uncollectable credit sales	0	0.078 (0.5% of15.675 )

after change  account recievable collection turnover ratio = 365/25

=14.6

average account recievables = 15.675/14.6

=$1.07 million

cost to carry account recievables =1.07*5%

=$ 0.0535 million

(4) uncollectable loss= $0.078 million (15.675*0.5%)