Use the model in File C15 to solve this problem.

Helen Bowers, the new credit manager of the Muscarella Corporation, was alarmed to find that Muscarella sells on credit terms of net 50 days whereas industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $3 million, Muscarella currently averages 60 days sales in accounts receivable. Bowers estimates that tightening the credit terms to 30 days would reduce annual sales to $2.6 million, but accounts receivable would drop to 35 days of sales. She also expects the level of bad debts to decrease from its current level of 5 percent to 3 percent with the change in credit terms, because the loss in sales will likely include many customers who are classified as having poorer credit than those who continue to purchase from Muscarella. In addition, collection costs will increase from $150,000 to $175,000 because the collection department will put more effort into collecting delinquent accounts.

Muscarellas variable cost ratio is 70 percent, and its marginal tax rate is 40 percent.

If the Muscarellas required rate of return is 11 percent, should the change in credit terms be made? Assume all operating costs are paid when inventory is sold.

Suppose that Bowers reevaluates her sales estimates because all other firms in the industry have recently tightened their credit policies. She now estimates that Muscarellas sales would decline to only $2.8 million if she tightens the credit policy to 30 days. All of the original information will remain the same as previously stated. Would the credit policy change be profitable under these circumstances?

On the other hand, Bowers believes that she could tighten the credit policy to net 45 days and pick

up some sales from her competitors. She estimates that sales would increase to $3.3 million and that the days sales outstanding (DSO) would fall to 50 days under this policy. But, this policy will increase bad debts to 6 percent. Should Bowers enact this change?

Bowers also believes that if she leaves the credit policy as it is, sales will increase to $3.4 million and the DSO will remain at 60 days. Should Bowers leave the credit policy alone or tighten it as described in either part b or part c? Bad Debts would be 5 percent.

After comparing the credit policies of other firms, Helen is exploring whether Muscarella should offer a cash discount for early payment. She estimates that if terms of 2/10 net 30 are offered sales will increase to $3.5 million and 15 percent of the customers would take the cash discount by paying on Day 10. The customers who do not take the cash discount are expected to pay on average on Day 50. Under this policy, collection costs would increase to $200,000 and bad debts would decrease to 4.5 percent. Should Muscarella offer cash these credit terms?

Which credit policy produces the highest value for Muscarella Corporation?