Q1. Harson Products currently has a conservative credit policy and is in the process of reviewing three other credit policies. The current credit policy (Policy A) results in sales of $12 million per year. Policies B and C involve higher sales, accounts receivable and inventory balances, as well as higher bad debt and collection costs. Policy D grants longer payment terms than Policy C, but charges customers interest if they take advantage of the lengthy payment terms. The policies are outlined below.
P o l i c y (000)
A B C D
Sales $12,000 $13,000 $14,000 $14,000
Average accounts receivable 1,500 2,000 3,500 5,000
Average inventory 2,000 2,300 2,500 2,500
Interest income 0 0 0 500
Bad debt expense 100 125 300 400
Collection cost 100 125 250 350
If the direct cost of products is 80% of sales and the cost of short-term funds is 10%, what is the optimal policy for Harson?
a. Policy A.
b. Policy B.
c. Policy C.
d. Policy D.
Q2. Foster Products is reviewing its trade credit policy with respect to the small retailers to which it sells. Four plans have been studied and the results are as follows.
Annual Bad Collection Accounts
Plan Revenue Debt Costs Receivable Inventory
A $200,000 $ 1,000 $1,000 $20,000 $40,000
B 250,000 3,000 2,000 40,000 50,000
C 300,000 6,000 5,000 60,000 60,000
D 350,000 12,000 8,000 80,000 70,000
The information shows how various annual expenses such as bad debts and the cost of collections change as sales change. The average balance of accounts receivable and inventory have also been projected. The cost of the product to Foster is 80% of the selling price, after-tax cost of capital is 15%, and Foster’s effective income tax rate is 30%. What is the optimal plan for Foster to implement?
a. Plan A.
b. Plan B.
c. Plan C.
d. Plan D.