Campbell Computing Inc.currently has sales of $1,000,000, and its days sales outstanding is 30 days.The financial manager estimates that offering longer credit terms would (1) increase the days sales outstanding to 50 days and (2) increase sales to $1,200,000.However, bad debt losses, which were 2 percent on the old sales, would amount to 5 percent on the incremental sales only (bad debts on the old sales would stay at 2 percent).Variable costs are 80 percent of sales, and Campbell has a 15 percent receivables financing cost.What would the annual incremental pre-tax profit be if Bass extended its credit period?
A) −$20,000
B) −$10,000
C) $0
D) $10,000
E) $20,000

Question

Quizplus · Accepted Answer

To calculate the annual incremental pre-tax profit from extending the credit period, we consider the increase in sales, the increase in bad debt losses on the incremental sales, and the cost of financing the additional receivables.1. Incremental sales = $1,200,000 - $1,000,000 = $200,0002. Incremental bad debt losses = 5% of $200,000 = $10,0003. Incremental variable costs = 80% of $200,000 = $160,0004. Incremental gross profit = Incremental sales - Incremental variable costs - Incremental bad debt losses = $200,000 - $160,000 - $10,000 = $30,0005. Incremental receivables = ($1,200,000/365 days) * 50 days - ($1,000,000/365 days) * 30 days = ($3,287.67 * 50) - ($2,739.73 * 30) = $164,383.56 - $82,191.78 = $82,191.786. Financing cost on incremental receivables = 15% of $82,191.78 = $12,328.77Therefore, the annual incremental pre-tax profit = Incremental gross profit - Financing cost on incremental receivables = $30,000 - $12,328.77 = $17,671.23, which is approximately $20,000 when rounded to the nearest option provided.