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QUESTION NO 3:
Maggie's Gold Coins, Inc. is considering shortening its credit period from 30 days to 20 days and
believes, as a result of this change, its average collection period will decrease from 36 days to 30
days. Bad debt expenses are also expected to decrease from 1.2 percent to 0.8 percent of sales.
The firm is currently selling 300,000 units but believes as a result of the change, sales will
decline to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total
$3,300,000, and fixed costs are $300,000. The firm has a required return on similar-risk
investments of 15 percent. Evaluate this proposed change and make a recommendation to the
firm.

Answer:

Decline in sales = [300,000 – 275,000] = 25,000 units

Selling price = [$42,00,000 / 300,000 units] = $14

Variable cost per unit = [$3300,000 / 300,000 units] = $11

Reduction in profit contribution margin from decline in sales= [300,000 – 275,000 units] X [$14-
$11] = $75,000
Cost of marginal investment in A/R:

Turnover with A/R with proposed plan: 360/30 = 12

Average investment with proposed plan= [275,000 units X $11/$12] = $252,083

Turnover of A/R with present plan = 360/36 = 10

Average investment with present plan = [300,000 units X $11/$10]= $330,000

Reduced investment in A/R= $77,917

Reduction in cost of marginal investment in A/R= $77,917 X 0.15 = $11,688.

Reduction in marginal bad debts:

Bad debts with present plan = (0.012) X $42, 00,000 = $50,400

Bad debts with proposed plan = 0.008 X 275,000 X $14= $30,800

Reduction in bad debts= $50,400 - $30,800 = $19,600

Net loss from implementing the proposed plan = ($75,000) + $11,688 + $19,800 = $43,712
the proposal is not accepted.