Van Doren Housing expects to have sales this year of $18 million under its current credit policy. The present terms are net 30; the days sales outstanding (DSO) is 48 days; and the bad debt loss percentage is 4 percent. Also, Van Doren’s cost of capital is 20 percent, and its variable costs total 75 percent of sales. Since Van Doren wants to improve its profitability, a proposal has been made to offer a 2 percent discount for payment within 10 days; that is, change the credit terms to 2/15 net 30. The consultants predict that sales would increase by $6,000,000, and that 50 percent of all customers would take the discount. The new DSO would be 30 days, and the bad debt loss percentage on all sales would fall to 2 percent.
a. What would be the cost to Van Doren of the discounts taken?
b. What would be the incremental bad debt losses if the change were made?
c. What would be the incremental cost of carrying receivables if the change were made?
d. What are the incremental pre-tax profits from this proposal?