The Bailey machine Tool company thinks it can increase sales by 10 million by lo
ID: 2621853 • Letter: T
Question
The Bailey machine Tool company thinks it can increase sales by 10 million by loosening its credit standards somewhat. The firm normally experiences bad debts of about 2% of sales, but marketing estimates that the incremental business would be from financially weaker customers who would not pay about 17% of the time. The firms gross margin is 18% (production related costs are 82% of revenue).
a) Should bailey lower its credit standards to get the new business?
b) Would your answer change if taking on the new business also involved incremental collection expense of $150,000 per year.
Explanation / Answer
The Bailey machine Tool company thinks it can increase sales by 10 million by loosening its credit standards somewhat. The firm normally experiences bad debts of about 2% of sales, but marketing estimates that the incremental business would be from financially weaker customers who would not pay about 17% of the time. The firms gross margin is 18% (production related costs are 82% of revenue).
a) Should bailey lower its credit standards to get the new business?
Gross Margin on Incremental Sales = 10 million*18% = $ 1,800,000
Bad Debt = 10Million*17% = $ 1,700,000
Net income would increase = $ 100,000
Yes, Bailey should accept its credit standards to get the new business
b) Would your answer change if taking on the new business also involved incremental collection expense of $150,000 per year.
Yes, The answer would change to refusing the Proposal of taking the new business which leads to net income decrease by $ 50000
Bailey should not accept its credit standards to get the new business if taking on the new business also involved incremental collection expense of $150,000 per year.
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