Question: Microboard Inc a major computer chip manufacturer is thinking of
Microboard Inc., a major computer chip manufacturer, is thinking of lengthening its credit period from net 30 days to net 50 days. Presently, its average collection period is 40 days, and the firm’s CFO believes that with the proposed new credit period, the average collection period will be 65 days. The firm’s sales are $900 million, and the CFO believes that with the new credit terms, sales will increase to $980 million. At the current $900 million sales level, the firm’s total variable costs are $630 million. The firm’s CFO estimates that with the proposed new credit terms, bad debt expenses will increase from the current level of 1.5% of sales to 2.0% of sales. The CFO also believes that the increased sales volume and accompanying receivables will require the firm to add more facilities and personnel to its credit and collections department. The annual cost of the expanded credit operations resulting from the proposed new credit period is estimated to be $10 million. The firm’s required return on similar-risk investments is 18%. Assume a 365-day year. Evaluate the economics of Microboard’s proposed credit-period lengthening, and make a recommendation to the firm’s management.
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