Cover’s, Inc (CI) sells its stainless steel products on terms of “2/10, net 40”. CI is considering granting credit to retailers with total assets as low as $500,000. Currently the lowest asset limit is $750,000. CI believes sales will increase $7 million from the new credit group but the average collection period for this new group will be 60 days versus the current average collection period of 35 days. If management estimates that 40% of the new customers will take the cash discount but 10% of the new business will be written off as bad-debt loss, should CI lower its credit standards?
Assume CI’s variable cost ratio is 0.7 and its required pretax rate of return on current assets investment is 15%. CI also estimates that an additional investment in inventory of $850,000 is necessary for the anticipated sales increase.