The Kranberry kids Kompany is in the volatile garment business. The firm has annual revenues of $250 million and operates with a 30% gross margin on sales. Bad debt losses average 3% of revenues. Kramberry is contemplating an easing of its credit policy in an attempt to increase sales. The loosening would involve accepting a lower-quality customer for credit sales. It is estimated that sales could be increased by $20 million a year in this manner with an increase in inventory investment of $2,000,000. Opportunity costs for inventory is 15%. However, the collections department estimates that bad debt losses on the new business would rum four times the normal level, and that internal collection efforts would cost an additional $ 1 million a year.
Show computations to explain if the change in policy should be made.
Bad debt loss rate = 3% x 4 = 12%
Margin on added revenue actually collected = $20M x .88 x .30 = $5.3M
The solution provides full calculations and explanations for the problem.