Davis Manufacturing Industries (DMI) produces and sells 20,000 units of a machine tool each year. All sales are on credit, and DMI charges all customers $500 per unit. Variable costs are $350 per...

Davis Manufacturing Industries (DMI) produces and sells 20,000 units of a machine tool each year. All sales are on credit, and DMI charges all customers $500 per unit. Variable costs are $350 per unit, and the fi rm incurs $2 million in fi xed costs each year. DMI’s top managers are evaluating a proposal from the fi rm’s CFO that the fi rm relax its credit standards to increase its sales and profi ts. The CFO believes this change will increase unit sales by 4 percent. Currently, DMI’s average collection period is 40 days, and the CFO expects this to increase to 60 days under the new policy. Bad debt expense is also expected to increase from 1 percent to 2.5 percent of annual sales. The fi rm’s board of directors has set a required return of 15 percent on investments with this level of risk. Assume a 365-day year. a. What is DMI’s contribution margin? By how much will profi ts from increased sales change if DMI adopts the new credit standards? b. What is DMI’s average investment in accounts receivable under the current credit standards? Under the proposed credit standards? What is the cost of this additional investment? c. What is DMI’s cost of marginal bad debt expense resulting from the relaxation of its credit standards? d. What is DMI’s net profi t/loss from adopting the new credit standards? Should DMI relax its credit standards?