[Anonymous]

Can some one please explain it to me…Thanks! Its from Becker.

Question CPA-04092

The following information regarding a change in credit policy was assembled by the Wilson Wax Company. The company has a required rate of return of 10 percent and a variable cost ratio of 60 percent.

Old Credit Policy New Credit Policy

Sales $3,600,000 $3,960,000

Average collection period 30 days 36 days

The pretax cost of carrying the additional investment in receivables, using a 360-day year, would be:

a. $5,760

b. $9,600

c. $8,160

d. $960

Explanation

Choice “a” is correct.

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Average Collection Period = Ave. AR / Credit sale per day, so Ave. AR = Ave. Collection Period * Credit sale per day.

Old Credit Policy: Ave. AR = 30 (Ave. collection) * $10,000 (Credit sale per day $3,600,000 / 360) = $300,000 * 60% (variable cost ratio) = $180,000

New Credit Policy: Ave. AR = 36 (Ave. collection) * $11,000 (Credit sale per day $3,960,000 / 360) = $396,000 * 60% (variable cost ratio) = $237,600

The difference between new AR and old AR $267,600 – $180,000 = $57,600 * 10% (required rate of return) = $5,760

The cost of carrying the additional investment in receivable is $5,760. Hope this help.

[Author]

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