Question
PLEASE SHOW STEPS Norton Wrench, a machine-tool company recently found out that one of its main competitors has tightened its credit standards. Norton's chief operating
PLEASE SHOW STEPS Norton Wrench, a machine-tool company recently found out that one of its main competitors has tightened its credit standards. Norton's chief operating officer has asked you to make a recommendation to the executive policy committee on whether the company should tighten its standards. The marketing department estimates that annual sales will drop $20,000 from the present level of $275,000. The variable cost ratio is 0.7 and will not change, according to one of the cost accountants. Variable expenses related to collections and credit administration are projected at 1.25% of sales under the existing standards but 1.45% of sales under the proposed standards. The bad-debt expense rate on both existing and incremental (lost) sales is estimated to be 7%. The DSO of 56 days is not expected to change and can be applied to any sales gained or lost due to a change in credit standards The company's annual cost of capital is 15%.
Draw a cash flow timeline for 1 day's sales under the proposed standards.
a. What is the value effect (Z) of this decision on 1 day's sales?
b. What is the overall value effect (NPV)?
c. Are there any nonfinancial considerations about which you believe the executive policy committee should be warned?
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