Larsen Ltd. (Larsen) manufactures electronic switches. As part of its focus on increasing sales, Larsen has offered credit terms of 3/10 net 60 for the past three years. Bad debts are currently 3% of monthly sales of $3.8 million. Variable costs are 45% of sales, of which 3% of sales are selling and administrative costs, and the balance is cost of goods sold. The average collection period is 35 days, with 60% of customers taking the discount. Inventory turnover is 5.25, which is consistent with the industry standard. Now that sales have levelled off, Larsen's management is reassessing its credit policy and looking to change its credit terms to be consistent with its competitors. If Larsen's credit policy changes to 2/10 net 40, management believes the following will happen: Sales will decline by 2%. There will be NO change in the variable cost percentage. There will be NO change in the inventory turnover rate. 55% of customers will take the new discount and pay on day 10, with 40% paying on day 40 and 5% paying late on day 60. Bad debts will decrease to 2% of sales. Larsen applies a 7.5% discount rate for analyzing working capital decisions. . Required: Calculate the total estimated annual incremental benefit or cost that will result from implementing this new credit policy, and recommend whether Larsen should change its policy. (14 marks) Larsen Ltd. (Larsen) manufactures electronic switches. As part of its focus on increasing sales, Larsen has offered credit terms of 3/10 net 60 for the past three years. Bad debts are currently 3% of monthly sales of $3.8 million. Variable costs are 45% of sales, of which 3% of sales are selling and administrative costs, and the balance is cost of goods sold. The average collection period is 35 days, with 60% of customers taking the discount. Inventory turnover is 5.25, which is consistent with the industry standard. Now that sales have levelled off, Larsen's management is reassessing its credit policy and looking to change its credit terms to be consistent with its competitors. If Larsen's credit policy changes to 2/10 net 40, management believes the following will happen: Sales will decline by 2%. There will be NO change in the variable cost percentage. There will be NO change in the inventory turnover rate. 55% of customers will take the new discount and pay on day 10, with 40% paying on day 40 and 5% paying late on day 60. Bad debts will decrease to 2% of sales. Larsen applies a 7.5% discount rate for analyzing working capital decisions. . Required: Calculate the total estimated annual incremental benefit or cost that will result from implementing this new credit policy, and recommend whether Larsen should change its policy. (14 marks)
