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incremental pre-tax profits

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East Lansing Appliances (ELA) expects to have sales this year of $15 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 60 days; and bad debt loss percentage is 5 percent. Since ELA wants to improve its profitability, the treasurer has proposed that the credit period be shortened to 15 days. This change would reduce expected sales by $500,000, but it would also shorten the DSO on the remaining sales to 30 days. Expected bad debt losses on the remaining sales would fall to 3 percent. The variable cost percentage is 60 percent, and the cost of capital is 15 percent.

A. What would be the incremental cost of carrying receivables if this change were made?

B. What are the incremental pre-tax profits from this proposal?

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https://brainmass.com/economics/personal-finance-savings/incremental-pre-tax-profits-129337

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A:
Average Receivables under current policy = Sales*DSO/365 = 15*60/365=2.466 million
Interest cost on receivables = 15%*2.466 million = 0.3699 million
Bad debt loss = bad debt loss percentage * accounts receivables = 5%*2.466 million = 0.1233 ...

Solution Summary

The incremental pre-tax profits are determined.

$2.19
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annual incremental pre-tax profit

Brain mass Inc currently has sales of $1,000,000, and its days sales outstanding is 30 days. The financial manager estimates that offering longer credit terms would (1) increase the days sales outstanding to 50 days and (2) increase sales to $1,200,000. However, bad debt losses, which were 2 percent on the old sales, would amount to 5 percent on the incremental sales only (bad debts on the old sales would stay at 2%). Variable cost are 80 percent of sales, and Bass has a 15 percent receivables financing cost. What would the annual incremental pre-tax profit be if Bass extended its credit period?

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