The Pettit Corporation has annual credit sales of $2 million. Current expenses f

Question

The Pettit Corporation has annual credit sales of $2 million. Current expenses for the collection department are $30,000, bad debt losses are 2% and the days sales outstanding is 30 days. Pettit is considering easing its collection efforts so that collection expenses will be reduced to $22,000 per year. The change is expected to increase bad debt losses to 3% and to increase the DSO to 45 days. In addition, sales are expected to increase to $2.2 million per year. Should Pettit relax collection efforts if the opportunity cost of funds is 12% , the variable cost ratio is 75% and it's marginal tax rate is 40%? All costs associated with production and credit sales are paid on the day of the sale.

Explanation / Answer

A) afer removing bad debt expense sales = 1960000

operating income = 0.25*1960000-30000 = 460000

net income = 0.6* 460000 = 276000

B) afer removing bad debt expense sales = 2134000

operating income = 0.25*2134000-22000 = 511500

net income = 0.6* 511500 = 306900

A) DSO = (365*av receivables)/CREDIT SALES .................

av receivables = (30*2*10^6) /365 = 16438.56.........

B) av receivables = (45*2.2*10^6) /365 = 271232.87

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