The Widget Company is considering a change in it’s credit standards. The company sells currently 15 000 units of Widgets. The sales price is 32€. The variable cost is 75% of the sales price. The relaxation of the credit standards should result in 15% sales increase. However, the average credit collection period increases to 60 days from current 20 days. It is also expected that bad debt loss would also increase from 1% to 3% of the sales. The company finances its current assets with short-term loans that carry 10% of interest.
a) Try to evaluate if a change in credit standards has a positive effect on the profits of the company or not. In order to do so, you will have to compare additional profits with increase in bad debt expense and financing costs of additional receivables.