Solved – Flint Distributors makes all sales on a credit basis, selling on terms of 2/10, net 30. Once a year, it evaluates the creditworthiness of all its customers.

Question

Flint Distributors makes all sales on a credit basis, selling on terms of 2/10, net 30. Once a year, it evaluates the creditworthiness of all its customers. The evaluation procedure ranks customers from 1 to 5, with 1 indicating the “best” customers. Results of the ranking are as follows.

Customer
Category
% of Bad DebtsDays Sales
Outstanding
Credit
Decision
Added Sales
if Credit
Extended to Category
1None10Unlimited
credit
None
2112Unlimited creditNone
3320Limited credit$375,000
4960Limited credit$190,000
51690Limited credit$220,000

The variable cost ratio is 70%. and Flints marginal tax rate is 40%. The cost of capital invested in receivables is 12%. What would be the effect on the profitability of extending unlimited credit to each of categories 3,4 and 5?

Answer

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