Questions and Problems

Basic

(Questions 1-5)

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Evaluating Credit Policy Bismark Co. is in the process of considering a change in its terms of sale. The current policy is cash only; the new policy will involve one period's credit. Sales are 60,000 units per period at a price of $500 per unit. If credit is offered, the new price will be $540. Unit sales are not expected to change, and all customers are expected to take the credit. Bismark estimates that 4 percent of credit sales will be uncollectible. If the required return is 3 percent per period, is the change a good idea? Credit Policy Evaluation The Air Walker Company sells 2,000 pairs of running shoes per month at a cash price of $105 per pair. The firm is considering a new policy that involves 45 days' credit and an increase in price to $108.25 per pair on credit sales. The cash price will remain at $105, and the new policy is not expected to affect the quantity sold. The discount period will be 15 days. The required return is 1 percent per month.

a. How would the new credit terms be quoted?

b. What is the investment in receivables required under the new policy?

c. Explain why the variable cost of manufacturing the shoes is not relevant here.

d. If the default rate is anticipated to be 10 percent, should the switch be made? What is the break-even credit price? The break-even cash discount?

Credit Analysis Silicon Wafers, Inc. (SWI), is debating whether or not to extend credit to a particular customer. SWI's products, primarily used in the manufacture of semiconductors, currently sell for $1,800 per unit. The variable cost is $1,100 per unit. The order under consideration is for 15 units today; payment is promised in 30 days.

a. If there is a 20 percent chance of default, should SWI fill the order? The required return is 2 percent per month. This is a one-time sale, and the customer will not buy if credit is not extended.

b. What is the break-even probability in part (a)?

c. This part is a little harder. In general terms, how do you think your answer to part (a) will be affected if the customer will purchase the merchandise for cash if the credit is refused? The cash price is $1,550 per unit.

Credit Analysis Consider the following information on two alternative credit strategies:

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