Labowski's Long Boards Inc. makes high-quality skateboards for recreational use. It wholesales its boards in groups of 10 for a package price of $1,500. Many of its customers have asked for credit terms to aid in purchasing the boards
The firm's finance department has estimated the following profile for its long boards and customer base:
Annual sales: 10,000 long board packages
Annual production costs per board package: $1,000
Lost sales if credit is not provided for customers: 1,200 long board packages
Default rate if all customers purchase on credit: 4.00%
What is the profit if the firm has a credit policy? What is the change in the profit if the firm moves from a cash-only policy to a credit policy? What is the dollar value of bad debts the firm expects to accumulate over a year? Given the bad-debt dollar amount, what is the maximum average amount per long board package that the firm should spend on credit screening?
What will be an ideal response?
Answer:
What is the profit if the firm has a credit policy?
Annual Sales × (Price - Cost) × (1 - default rate) - Annual Sales × default rate × COGS
10,000 × ($1,500 - $1,000) × (1 - 0.04) - 10,000 × 0.04 × $1,000 = $4,400,000
What is the change in the profit if the firm moves from a cash-only policy to a credit policy?
Profit with credit - Profit without credit
(Annual Sales × (Price - Cost) × (1 - default rate) - Annual Sales × default rate × COGS) - (Cash-only Annual Sales × (Price - COGS))
= (10,000 × ($1,500 - $1,000) × (1 - 0.04) - 10,000 × 0.04 × $1,000) - (8,800 × (1,500 - 1,000))
=$4,400,000 - $4,400,000 = $0.00.
What is the dollar value of bad debts the firm expects to accumulate over a year?
Annual Sales (% bad debt) × (COGS per unit)
10,000 × (0.04) × ($1,000) = $400,000
Given the bad debt dollar amount, what is the maximum average amount per long board package that the firm should spend on credit screening?
Maximum spending = Change in the profit divided by the number of units sold.
$0.00 since the additional profit is $0.00.
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