Travel and Tow Trailers Inc. makes small trailers for light-duty towing behind SUVs and small pickup trucks

Question

Its trailers typically sell for $2,500. Many of its customers have asked for credit terms to aid in purchasing the trailers. The firm's finance department has estimated the following profile for its light-duty trailers and customer base:
Annual sales: 10,000 trailers
Annual production costs per trailer: $1,500
Lost sales if credit is not provided for customers: 2,000 trailers
Default rate if all customers purchase on credit: 3.00%

What is the change in the profit if the firm moves from a cash-only policy to a credit policy?
A) $1,250,000
B) $8,000,000
C) $9,250,000
D) $15,000,000

Answer 1

Answer: A
Explanation: A) Profit with credit policy = $9,250,000; profit without a credit policy = $8,000,000, and the difference is $1,250,000.
Solution with credit policy:
Trailers sold × (Price - Cost) - Bad Debt = 9,700 × ($2,500 - $1,500) - bad debt = $9,700,000 - (0.03 × 10,000) × $1,500 = $9,250,000.
Solution without credit policy:
Trailers sold × (Price - Cost) = 8,000 × ($2,500 - $1,500) = $8,000,000.