Papa Doc’s Pig Products sells its hams for $20 each. All sales are on credit and last year amounted to 75,000 hams. The variable cost per ham is $12. The firm’s total fixed costs are $300,000.
Papa Doc’s is currently contemplating a relaxation of credit standards that is expected to result in a 4 percent increase in ham sales to 78,000 hams, an increase in the average collection period from its current level of 30 days to 45 days and an increase in bad debt expenses from the current level of 1 percent of sales to 2 percent.
The firm’s required return on equal risk investments, which is the opportunity cost of tying up funds in accounts receivable, is 15 percent.
a. Calculate the additional profit contribution from sales expected to result from this relaxation of credit standards.
b. Calculate the marginal investment in accounts receivable and the additional marginal cost of accounts receivable.
c. Calculate the cost of marginal bad debts.
d. Calculate the net profit or net loss that would result from the decision to relax credit standards.
e. Should the credit standards be relaxed? Why or why not?