Relaxation of credit standards
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Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to 11,000 units during the coming year; the average collection period is expected to increase from 45 to 60 days; and bad debts are expected to increase from 1% to 3% of sales.
The sale price per unit is $40, and the variable cost per unit is $31. The firm's required return on equal-risk investments is 25%.
Evaluate the proposed relaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)
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The solution explains how to evaluate a relaxation of credit standards
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Additional profit contribution from sales:
1,000 additional units x ($40 - $31) $ 9,000
Cost of additional investment in Receivables
Average investment, ...
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