Use this formatted Excel spreadsheet to answer questions on the scenarios below. (Add information from the scenario into the Input Data section and then refer to Key Outputs section of the spreadsheet for answers to the posed questions. Percentages need to be entered in decimal format, for instance 3% would be entered as .03.)
Click Submit Assignment to type in the answer the following scenarios:
Helen Bowers, the new credit manager of the Muscarella Corporation, was alarmed to find that Muscarella sells on credit terms of net 50 days whereas industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $3 million, Muscarella currently averages 60 days’ sales in accounts receivable. Bowers estimates that tightening the credit terms to 30 days would reduce annual sales to $2.6 million, but accounts receivable would drop to 35 days of sales. She also expects the level of bad debts to decrease from its current level of 5% to 3% with the change in credit terms, because the loss in sales will likely include many customers who are classified as having poorer credit than those who continue to purchase from Muscarella. in addition, collection costs will increase from $150,000 to $175,000 because the collection department will put more effort into collecting delinquent accounts. Muscarella’s variable cost ratio is 70% and its marginal tax rate is 40%. (This information is shown on the spreadsheet provided.)
If the Muscarella’s required rate of return is 11%, should the change in credit terms be made? Why or why not? Assume all operating costs are paid when inventory is sold.
Suppose that Bowers reevaluates her sales estimates because all other firms in the industry have recently tightened their credit policies. She now estimates that Muscarella’s sales would decline to only $2.8 million if she tightens the credit policy to 30 days (DSO-nondiscount customers). Would the credit policy change be profitable under these circumstances? Why or why not?
On the other hand, Bowers believes that she could tighten the credit policy to net 45 days and pick up some sales from her competitors. She estimates that sales would increase to $3.3 million and that the days sales outstanding (DSO-nondiscount customers) would fall to 50 days under this policy. However, this policy will increase bad debts to 6%. Should Bowers enact this change? Why or why not?
Bowers also believes that if she leaves the credit policy as it is, sales will increase to $3.4 million and the DSO-nondiscount customers will remain at 60 days. Bad debts would be 5%. Should Bowers leave the credit policy alone or tighten it as described in either Question 1 or 2? Explain your answer.
After comparing the credit policies of other firms, Helen is exploring whether Muscarella should offer a cash discount for early payment. She estimates that if terms of 2/10 net 30 are offered sales will increase to $3.5 million and 15% of the customers wold take the cash discount by paying on Day 10 (DSO-discount customers). The customers who do not take the cash discount are expected to pay on average on Day 50 (DSO-nondiscount customers). Under this policy collection costs would increase to $200,000 and bad debts would decrease to 4.5%. Should Muscarella offer cash discounts under these credit terms? Why or why not?
