Mr. Walker, a credit manager of a company, discovered that the industrywide credit terms are net 60 days, while his firm sells on credit terms of net 90 days. Current sales are $5 million per year. The company currently averages 105 days of sales in accounts receivable.

Walker estimates that tightening terms to the industry average of 60 days will reduce annual sales to $4 million but that accounts receivable will drop to 70 days of sales and the bad debt ratio will drop from 3% to 1% of sales. The company has a variable cost ratio of 75%, and its cost of funds is 12% on its line of credit.

Current Policy Proposed Policy

Sales $5 M $4 M

Terms 90 days 60 days

Bad debts 3% 1%

In an estimation of the NPV of the impact of the proposed change, the dollar cost of bad debts will fall and the NPV will incease by:

a) None of the other answers is correct

b) $200,000

c) $72,500

d) $110,000

e) $82,500