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Suppose a firm that currently does not grant credit is considering to adopt a credit policy that will permit its customers to pay the full price for purchases within 30 days of the purchase. The firm estimates that it can increase the price of the product by $2 per unit to $112, with annual sales increasing from 10,000 to 11,000 units, and per unit variable costs not changing from $99. It also estimates that annual bad debt losses will amount to $5,000 and an A/R clerk will have to be hired part-time to track receivables and make collection calls, at an annual cost of $20,000. The firm plans to finance the working capital investment by using its line of credit charging 6% EAR interest.
Problem 1: lf the firm's tax rate is 40%, then should the firm adopt the policy?
Problem 2: lf the above firm wishes to switch from net 30 to 2/10, n/30, then calculate the effective annual cost of customers forgoing the discount.
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