Problem:
Valley Clothing Shop is a small clothing retailer now in its fourth year of business. Through its first year of operations, Valley has operated on a pure cash or check basis. Currently, Valley has averaged $275,000 of annual cash sales with an average profit margin of 40%. Lately, many customers have expressed frustration over the fact that Valley does not accept credit sales, and Valley believes that this is beginning to have a substantial negative impact on the business. Valley is contemplating two plans of action, neither of which will impact the company's current cash sales.
Plan 1:
Offer qualified customers the opportunity to purchase merchandise on account. Valley believes this will create new credit sales of 18% of current cash sales. Increased expenses would include 4% of net credit sales related to bad debts, 2% of net credit sales for billing, and 1% of net credit sales for increased record keeping.
Plan 2:
Begin accepting credit cards. Valley believes this will create new credit sales of 23% of current cash sales. Increased expenses would include 5.5% of net credit sales-related credit card fees and 0.5% of net credit sales for increased record keeping.
Required to do:
a. Compute net income under each plan assuming a tax rate of 30%.
b. Which plan would you recommend Valley accept?
c. What other factors should Valley consider when evaluating these options?