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Chapter 3: 20BP_b (page 224)

Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide \(180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur \)16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket. No other asset build-up will be required to service the new customers. The firm has a 10 percent desired return. Assume the average collection period is 120 days.

b. Should credit be extended?

Short Answer

Expert verified

The company should not extend credit to these customers.

Step by step solution

01

Factors to be considered when extending credit

The company should consider the following credit before extending credit:

  1. The credit risk of the company after extending the credit.
  2. The credit terms agreed upon between the parties for extending credit.
  3. The ability of the customer to timely repay the credit.
02

Decision for extending credit

The expected incremental return is 7.92% but the company has the desired return of 10%, so the company should not extend credit to these customers.

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