Question

Fashion Distributors Incorporated currently sells on terms of 2/10, net 30, with bad debt losses at 1% of
gross sales. Of the 99% of the customers that pay, 50% take the discount and pay on Day l0; the remaining
50% pay on Day 30 (average collection period of 20 days).
FDI's gross sales are currenly $2 million per year, with variable costs amounting to 75oz of sales. The firm
finances its receivables with a 10% line of credit, and there are sufficient fixed assets to support a doubling
in sales.
FDI's credit manager has proposed that credit terms be changed to 2/10, net 50. It is estimated that these
terms will boost sales to $2.75 million per year. However, bad debt loss€s will double to 2% of the new
sales level. It is expected that 50% of the paying customers will continue to take the discount and pay on
Day 10, and the other 50% will pay on Day 50.
REQUIRED:
a) What is the new average collection period?
b) Should the change in credit terms b€ made? Justify your answer and show all relevant calculations,
as well as any assumptions necessary.