Reference no: EM132874334

Question - Working Capital Management - Credit Sales - Over the last few years, specialty coffee shops have expanded in the east coast due to the influence that the presence of Starbucks has had on coffee trends. In an effort to boost sales, the credit department at Silverston Coffee Merchants, a wholesaler of specialty imported coffee beans, has approved credit sales to cafés that have not had a long operating history. Silverston has enjoyed an impressive growth in revenue to $400 million. However, bad debt expense has increased from 3% to 6% of sales. Silverston knows that not all the new cafes will survive, but as the competition diminishes, the few remaining shops will have a dominant market share and will be profitable.

The finance department would like to adopt a new credit policy which would reduce credit sales, resulting in an overall sales reduction of 8%, but a decrease in bad debt expense to 2.6% of sales. The company has an operating profit margin of 38%, before bad debt expense and other costs associated with the credit policy. If it adopts the stricter credit policy, the company's average collection period would decrease from 50 days to 40 days. The company's financing rate of 6% will remain the same. Implementing the new credit policy would require $500,000 in additional annual overhead costs.

Required -

a. Should Silverston implement the new credit policy? Write recommendation to the company in the form of a memo clearly explaining your position.

Calculate the following to support your recommendation:

i. What is EBT now with the existing credit policy? Show your calculations

ii. What will EBT be with the new credit policy? Show your calculations.

b. Suggest 2 other factors that the company should consider, other than the savings in bad debt expense, in implementing the new credit policy.