Problem 1 Working Capital Management/Credit Policy (5%)

A company is planning to change its credit policy. The details are as follows:

Current selling price $5.00 per unit

Average cost $4.50 per unit

Current annual sales 360,000 units

Current terms of sale net 30 days

The company wants to extend its credit period to net 60 days. Allowing for the

reaction of competitors, it is anticipated that this move would produce the following

results:

1. Sales are expected to increase to 420,000 units.

2. Bad debt losses are expected to increase by $6,000 per year.

The marginal cost per unit for the increased number of units to be produced

would be $3.00. The companys after-tax rate is 40%, and its required minimum rate

of return on such investments is 15% after tax.

Question

Would you recommend that the company adopt this new credit policy? Please ensure to show your work. You wont get full marks if you just provide your final answer.