Rich Jackson, a recent finance graduate, is planning to go into the wholesale building supply business with his brother, Jim, who majored in building construction. The firm would sell primarily to general contractors, and it would start operating next January. Sales would be slow during the cold months, rise during the spring, and then fall off again in the summer, when new construction in the area slows. Sales estimates for the first 6 months are as follows (in thousands of dollars):

The terms of sales are net 30, but because of special incentives, the brothers expect 30% of the customers (by dollar value) to pay on the 10th day following the sale, 50% to pay on the 40th day, and the remaining 20% to pay on the 70th day. No bad debt losses are expected because Jim, the building construction expert, knows which contractors are having financial problems.

Assume now it is several years later. The brothers are concerned about the firm€™s current credit terms, now net 30, which means that contractors buying building products from the firm are not offered a discount and are supposed to pay the full amount in 30 days. Gross sales are now running $1,000,000 a year, and 80% (by dollar volume) of the firm€™s paying customers generally pay the full amount on Day 30, while the other 2.0% pay, on average, on Day 40. Of the firm€™s gross sales, 2% end up as bad debt losses.
The brothers are now considering a change in the firm€™s credit policy. The change would entail
(1) Changing the credit terms to 2/10, net 20,
(2) Employing stricter credit standards before granting credit, and
(3) Enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2% discount, but all others would have to pay the full amount after only 20 days. The brothers believe the discount would both attract additional customers and encourage some existing customers to purchase more from the firm-after all, the discount amounts to a price reduction. Of course, these customers would take the discount and, hence, would pay in only 10 days. The net expected result is for sales to increase to $1,100,000, for 60% of the paying customers to take the discount and pay on the 10th day, for 30% to pay the full amount on Day 20, for 10% to pay late on Day 30, and for bad debt losses to fall from 2% to 1% of gross sales. The firm€™s operating cost ratio will remain unchanged at 75%, and its cost of carrying receivables will remain unchanged at 12%.
To begin the analysis, describe the four variables that make up a firm€™s credit policy, and explain how each of them affects sales and collections. Then use the information given in part h to answer parts j throughq.

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ayS200 100 $100 arch S300 Mav January February April 300 June 200 Predicted A/R-to- Month Predicted Sales Sales Ratio to Receivables lanuary February March $150 00 500 0% 20 70 3 60 350 Projected March 31 A/R balance # S410 Apri $400 May une 300 200 Projected June 30 A/R balance