Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Given: All sales on credit Old credit terms New credit terms 2/15, n40 2/15, n60 Sales expected under old credit policy: Sales change expected with new credit policy: $350,000 20% increase Under old credit policy: 40% of customers take discount, pay in 58% of customers pay at the end of 2% of customers pay in 15 days 40 days 100 days Under new credit policy: 30% of customers take discount, pay in 60% of customers pay at the end of 10% of customers pay in 15 days 60 days 100 days 2% Bad debt expenses under old credit policy: Bad debt expenses under new credit policy: of sales of sales 4% Short-term interest rate Long term interest rate Income tax rate Cost of capital Cost of goods sold Other operating expenses 7% 10% 40% 11% 80% of sales $10,000 under old credit policy Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question a: Average collection period under old policy Average collection period under new policy days (weighted average of custome days (weighted average of custome Accounts Receivable under old policy Accounts Receivable under new policy AR = ACP * Credit sales per day AR = ACP * Credit sales per day * Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question b: East-West Trading Company Financial Statements INCOME STATEMENT With old credit terms: 2/15, n40 (given) With new credit terms: 2/15, n60 (pro forma) 20% increase increase in proportion with sales Sales (all on credit) Cost of Goods Sold Gross Profit Bad debt expenses Other operating expenses Operating Income Interest Expense Before-Tax Income Income Taxes Net Income $350,000 280.000 70,000 7,000 10.000 53,000 5.450 47,550 19.020 $28,530 from assumptions increase in proportion with sales (ST Debt * ST Cost of Debt) + (LT Debt * LT CC BALANCE SHEET, as of Dec 31 $15,000 0 50.000 65,000 120,000 $185.000 increase in proportion with sales from Tab a increase in proportion with sales same Assets Current Assets: Cash & Securities Accounts Receivable Inventory Total Current Assets Property, Plant & Equipment, Net Total Assets Liabilities & Equity Current Liabilities: Accounts Payable Notes Payable Total Current Liabilities Long-Term Debt Total Liabilities Common Stock Capital in Excess of Par Retained Earnings Total Stockholders' Equity Total Liabilities & Equity increase in proportion with sales increase in proportion with sales same $14,918 35.000 49,918 30.000 79,918 25,000 60,000 50.000 135.000 $185.000 same same same AFN to balance: obtain from ST sources Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question c: Incremental cash flows associated with the credit policy change Initial investment at T-O AFN from Tab B Future incremental cash flows, T-1 onward: Inflows: Increase in Sales Outflows: Increase in Cost of Goods Sold Increase in Bad Debt Expense Increase in Other Operating Exps Increase in Interest Expense Increase in Taxes Total Outflows Net future incremental cash flows each year from T-1 onward Question d, Investment Decision: NPV of the Credit Policy Change: Initial Investment Future Cash Flows $0 $0 per year NPV = at a cost of capital of 11% Comments: Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Given: All sales on credit Old credit terms New credit terms 2/15, n40 2/15, n60 Sales expected under old credit policy: Sales change expected with new credit policy: $350,000 20% increase Under old credit policy: 40% of customers take discount, pay in 58% of customers pay at the end of 2% of customers pay in 15 days 40 days 100 days Under new credit policy: 30% of customers take discount, pay in 60% of customers pay at the end of 10% of customers pay in 15 days 60 days 100 days 2% Bad debt expenses under old credit policy: Bad debt expenses under new credit policy: of sales of sales 4% Short-term interest rate Long term interest rate Income tax rate Cost of capital Cost of goods sold Other operating expenses 7% 10% 40% 11% 80% of sales $10,000 under old credit policy Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question a: Average collection period under old policy Average collection period under new policy days (weighted average of custome days (weighted average of custome Accounts Receivable under old policy Accounts Receivable under new policy AR = ACP * Credit sales per day AR = ACP * Credit sales per day * Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question b: East-West Trading Company Financial Statements INCOME STATEMENT With old credit terms: 2/15, n40 (given) With new credit terms: 2/15, n60 (pro forma) 20% increase increase in proportion with sales Sales (all on credit) Cost of Goods Sold Gross Profit Bad debt expenses Other operating expenses Operating Income Interest Expense Before-Tax Income Income Taxes Net Income $350,000 280.000 70,000 7,000 10.000 53,000 5.450 47,550 19.020 $28,530 from assumptions increase in proportion with sales (ST Debt * ST Cost of Debt) + (LT Debt * LT CC BALANCE SHEET, as of Dec 31 $15,000 0 50.000 65,000 120,000 $185.000 increase in proportion with sales from Tab a increase in proportion with sales same Assets Current Assets: Cash & Securities Accounts Receivable Inventory Total Current Assets Property, Plant & Equipment, Net Total Assets Liabilities & Equity Current Liabilities: Accounts Payable Notes Payable Total Current Liabilities Long-Term Debt Total Liabilities Common Stock Capital in Excess of Par Retained Earnings Total Stockholders' Equity Total Liabilities & Equity increase in proportion with sales increase in proportion with sales same $14,918 35.000 49,918 30.000 79,918 25,000 60,000 50.000 135.000 $185.000 same same same AFN to balance: obtain from ST sources Problem 19-8 East-West Trading Company Credit Policy Analysis (Revised) Question c: Incremental cash flows associated with the credit policy change Initial investment at T-O AFN from Tab B Future incremental cash flows, T-1 onward: Inflows: Increase in Sales Outflows: Increase in Cost of Goods Sold Increase in Bad Debt Expense Increase in Other Operating Exps Increase in Interest Expense Increase in Taxes Total Outflows Net future incremental cash flows each year from T-1 onward Question d, Investment Decision: NPV of the Credit Policy Change: Initial Investment Future Cash Flows $0 $0 per year NPV = at a cost of capital of 11% Comments