The credit terms that Whuten Ltd. currently offers its customers are net 45, and virtually...
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The credit terms that Whuten Ltd. currently offers its customers are net 45, and virtually all customers pay roughly on day 45. Whuten currently experiences no bad debts. This means that Whutens accounts receivable balance remains constant at 12.5% of sales.
The credit department would like to change the terms that it offers customers from net 45 to 2/10 net 60. The forecasted consequences of this credit policy change are as follows:
Sales are expected to increase from $7.56 million to $7.89 million.
The increased sales will increase efficiency such that its variable cost of goods sold (COGS) is expected to fall from its current level of 60% of sales to 57.5% of sales.
Under the proposed credit terms, bad-debt expense is expected to be 1% of sales.
60% of customers are expected to take advantage of the credit terms and 39% are expected to pay on day 60. (1% are bad debts and will never pay.)
The rate of return that Whuten expects from its investments in working capital is 3.5% (before tax).
Required:
Determine whether or not Whuten should proceed with the change in credit terms.
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