First Picked Fruits Inc. is considering two alternatives to stimulate sales. Currently, the policy is net 30 and the average collection period is 40 days, with bad debt losses of 1.25 percent of sales. All sales are credit sales and are expected to be $6.1 million annually under this policy.
Under policy 1, credit terms would be lengthened to 45 days to a select group of new customers, with an expected increase in sales to $6.9 million annually. However, it is expected that the incremental sales would experience bad debt losses of 1. 75 percent and that their average collection period would be 50 days. No change would occur in the average collection period or bad debt loss experience on the existing credit sales. Under policy 2, credit terms would be lengthened to 60 days to a select group of new customers (not completely overlapping with the first group). Sales would be expected to rise to $7.2 million annually. Incremental sales expectations would be payment, on average, after 65 days, and bad debt losses of 2 percent. No change would occur in the average collection period or bad debt losses on the original credit sales. First Picked Fruits has an opportunity cost of funds of 16 percent, and its variable costs are 94 percent of sales.
a. Is either alternative advantageous?
b. Any concerns with this analysis as stated?
c. Any theoretical concerns with an apparent one-year time horizon for analysis?