Ellington Knitwears president is convinced that the company must lengthen the credit period it offers...
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Finance
Ellington Knitwears president is convinced that the company must lengthen the credit period it offers to its customers. As the analyst assigned to run the numbers, you have determined that such a move will increase sales from $100 million to $105 million per year. The VCR is 0.65 and will not change, and the credit and collection expenses will increase from 2 percent to 2.5 percent under the proposal. DSO under the present 30-day terms is 42 days; under the proposed 45-day terms it will be 52 days. The bad debt loss rate is currently 2.5 percent and it will not change for the additional sales. The companys annual cost of capital is 12 percent.
Calculate the ZE, that is, the NPV of 1 days sales under the current terms. Calculate the ZN, that is, the NPV of 1 days sales under the proposed terms.
Calculate Z. Should the company switch to the proposed terms? Why or why not?
What is the aggregate value added by the lengthened terms, assuming the daily change persists indefinitely into the future?
Calculate the ZN, if the bad debt loss rate under the new credit terms is higher (3.3% versus 2.5%).
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