Reference no: EM132743296

Fishoeder Realty, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them. This policy results in lost sales of $6 million annually. Based on experience with these types of customers, the firm estimates that the average collection period would be 140 days and that the bad-debt loss ratio would be 15%. The firm's variable cost ratio is 0.55, making its profit contribution ratio 0.45. Fishoeder Realty would invest an additional $2 million in inventory. Fishoeder Realty' required pretax return (i.e., opportunity cost) on receivables and inventory investments is 17.5%. When converting from annual to daily data or vice versa, assume there are 365 days per year.

Problem 1: Determine the net effect on Fishoeder Realty' pretax profits of extending credit to these (previously delinquent) customers. Should the firm proceed with the credit extension?