Credit Policy. The Heap Corporation finds itself with excess manufacturing capacity. The company has lost a portion of its share of the market over the past several years. This, in part, may be due to Heap having a more conservative credit policy than is common in the industry.
Heap Corporation Industry
Terms 2/10, net/30 (%) 2/10, net/30 (%)
Credit granted as percent of applicants by credit class
A 100 100
B 100 100
C 25 70
D 11 40
E 2 20
F 0 5
Average collection period 30 days 60 days
The vice-president for finance recommends that Heap Corporation relax its credit standards, with the expectation that sales and profitability will increase. Staff studies show that credit sales can be expected to increase to $92 million, bad debt losses will be approximately $2.4 million, inventory will need to be increased by $5.67 million, and average collection of accounts receivable will be 60 days. The 20X2 Heap income statement is given below.
Heap Corporation Income Statement (in Thousands of Dollars) For Year Ended December 31, 20X2
Revenue
Credit sales $ 72
Cash sales 8 $80
Costs and other charges
Manufacturing expensesa
$57.4
Administrative expensesb
3.0
Selling expensesc
9.6 70
Net income before taxes $10
Federal income tax 5
Net income $ 5
a
Materials and supplies $ 10.0
Labor 40.0
Fixed overhead 7.4
$ 57.4
“All fixed $ 3.0
“ Selling expenses
Variable expense $ 8.0
Bad debt loss estimate 1.6
$ 9.6
(a) Estimate the accounts receivable balance at December 31, 20X2. (b) Assuming total assets at December 31, 20X2 equal 40 million dollars: (1) What is Heap Corporation’s return on corporate assets? (2) What is the asset turnover? (c) What profit margin will Heap Corporation earn if the predictions are correct? (d ) What return should be expected on corporate assets if the policy is adopted and the predictions are correct? (e) Will the company be better off financially if the proposed change in credit policy is made? Explain your answer. (CMA, adapted.)