Sheep Shank Farms Ltd is considering extending the credit period offered to customers from 30 to 60 days. It is expected that customers will continue to pay on the net date. The company currently generates $450,000 in credit sales per annum with associated variable costs of $345,000. The change in credit terms is expected to increase credit sales to $510,000. Bad-debt expense is anticipated to increase from 1% to 1.5% as a result of lengthening the credit period. The company’s required rate of return on equal-risk investments is 20%.
Required:
a. What additional profit contribution from sales will be realised from the proposed change?
b. What is the cost of the marginal investment in accounts receivable?
c. What is the cost of the marginal bad debts?
d. Do you recommend the proposed change in credit terms? Why or why not?