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10. Analyzing proposed changes in credit policy

A credit policy covers how customers qualify for credit, the maximum amount of credit that customers are allowed, the terms of credit sales, and what actions will be taken if customers do not pay on time. To ensure that the credit policy is being followed and that it is achieving the desired objective, it should be monitored. If customers payment patterns change significantly, the firm should consider changing its credit policy.

Which statement best describes whether a proposed change in credit policy should be implemented?

A policy that reduces the average collection period should be implemented.

A policy that provides the lowest bad debts with the least amount of effort should be implemented.

A policy that provides the lowest average collection period should be implemented.

A policy should be implemented if the added benefits exceed the costs based on present value.

A new financial manager at Williams Company has proposed a change to the companys credit policy in order to lower the average collection period of the customers who forgo the discount by 10 days. The cost of the increased credit effort is $10 million, and the manager estimates that the company will lose 5% in gross sales as a result. The discount customers will not be affected.

The proposed data, including the daily data, is reflected in the following table.

	Existing Policy	Proposed Policy
I. General Credit Policy Information
Credit terms	2/10 net 30	2/10 net 30
(Average collection period (ACP) for all customers	46.0 days	37.0 days
ACP for customers who take the discount (10%)	10.0 days	10.0 days
ACP for customers who forgo the discount (90%)	50.0 days	40.0 days
II. Annual Credit Sales and Costs ($ milllions)
Amount paid by discount customers	$189	$189
Amount paid by nondiscount customers	$1,440	$1,360
Net credit sales	$1,629	$1,549
Variable operating costs (82% of net sales)	$1,336	$1,270
Bad debts	$0.0	$0.0
Credit evaluation and collection costs	$160	$170.00
III. Daily Credit Sales and Costs ($ thousands)
Net sales	$4,525	$4,303
Amount paid by discount customers	$525	$525
Amount paid by nondiscount customers	$4,000	$3,778
Variable operating costs (82% of net sales)	$3,711	$3,528
Credit evaluation and collection costs	$444	$472

Your job is to review the proposal and make a recommendation. To simplify your analysis, assume that sales occur evenly throughout the year, that the variable operating costs and the credit evaluation and collection costs are incurred at the time of sale, and that a 360-day year is used to compute the daily figures. Williamss cost of capital is 7.5%.

Complete the following sentences.

Williams SHOULD/SHOULD NOT institute the proposed policy change, because the existing policy provides a net present value of $328/271/4478/368 compared to the proposed policy, which provides a net present value of $328/271/4267/302 .

Since this change is expected to have a permanent and continuing effect, this daily difference of $222/-66/211/-57 will DECREASE/INCREASE the value to the firm by $273604/20518859/1012816/1065617 .

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