Problem:
(Marginal analysis) The Bandwagonesque Corporation is considering relaxing its current credit policy. Currently, the firm has annual sales (all credit) of $5 million and an average collection period of 60 days (assume a 360-day year). Under the proposed change, the trade credit terms would be changed from net 60 to net 90 days and credit would be extended to a riskier class of customer. It is assumed that bad debt losses on current customers will remain at their current level. Under this change, it is expected that sales will increase to $6 million. Given the following information, should the firm adopt the new policy?
New sales level (all credit) $6,000,000
Original sales level (all credit) $5,000,000
Contribution margin 20%
Percent bad debt losses on new sales 8%
New average collection period 90 days
Original average collection period 60 days
Additional investment in inventory $50,000
Pre-tax required rate of return 15%