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Credit Policy Evaluation

The Johnson Company sells 3,000 pairs of running shoes per
month at a cash price of $90 per pair. The fi rm is considering a new policy that involves 30 days' credit and an increase in price to $91.84 per pair on credit sales. The cash price will remain at $90, and the new policy is not expected to affect the quantity sold. The discount period will be 10 days. The required return is 1 percent per month.

a. How would the new credit terms be quoted?
b. What is the investment in receivables required under the new policy?
c. Explain why the variable cost of manufacturing the shoes is not relevant here.
d. If the default rate is anticipated to be 10 percent, should the switch be made? What is the break-even credit price? The break-even cash discount?

Solution Preview

a. How would the new credit terms be quoted?

In order to quote the new credit terms, we need to find the cash discount.
The cash discount is 91.84X(1-cash discount %) = 90 (which is the cash price)
1- Cash discount = 90/91.84 = .98
Cash Discount = 1-.98 = 2%
The discount period is 10 days and the total credit period is 30 days
The new terms are 2/10 net 30

b. What is the investment in receivables required under the new policy?

In order the find the investment in new policy we need to know how many customers will take the discount. This information is not given. Assuming ...

Solution Summary

The solution explains the calculations relating to a change in credit policy

$2.19