Let's break down the problem step by step: ## Step 1: Calculate the firm's current monthly revenue. - **Annual sales (current):** 10,500 units - **Sale price per unit:** $38 ### Annual Revenue (Current) \[ \text{Annual Revenue} = 10{,}500 \times \$38 = \$399{,}000 \] ### Monthly Revenue (Current) \[ \text{Monthly Revenue} = \frac{\$399{,}000}{12} = \$33{,}250 \] --- ## **Answer to the Box** The monthly revenue under the current plan is **\$33,250.00**. --- If you need further calculations for the proposal (profit, costs, bad debts, etc.), let me know!

**1. Introduction** Understanding the implications of relaxing credit standards involves analyzing how extending credit to customers affects a firm's sales volume, accounts receivable, bad debts, and overall profitability. When a company traditionally operates on cash sales, all revenue is received immediately, and there are no concerns about collection periods or bad debts. However, offering credit introduces a delay in cash inflows, potentially increasing sales but also raising risks and costs associated with longer collection periods and higher bad debt expenses. Key concepts relevant to this analysis include: - **Sales Volume and Revenue:** Extending credit can stimulate higher sales volume due to increased customer convenience, which in turn affects total revenue. - **Accounts Receivable and Collection Period:** Offering credit lengthens the time between sale and cash receipt, impacting cash flow and working capital management. - **Bad Debts:** The risk of customers defaulting increases with credit extension, leading to potential losses. - **Cost of Capital:** The firm’s required return on investment, which must be considered when evaluating the opportunity cost of funds tied up in receivables. - **Incremental Analysis:** Comparing the additional revenues and costs resulting from the credit policy change helps determine financial viability. This background provides the foundation for evaluating whether relaxing credit standards will enhance profitability and aligns with the firm’s financial goals. **Explanation:** This introduction emphasizes the critical financial concepts involved in credit management decisions. Understanding how sales, receivables, bad debts, and costs interplay enables a comprehensive assessment of the proposal’s impact. The concepts serve as the basis for subsequent quantitative analysis, ensuring that the evaluation considers both potential benefits and risks. --- **2. Presentation of Relevant Formulas Required To Solve The Question** The following formulas are essential for analyzing the impact of extending credit: a) **Monthly Sales Revenue (Current and Proposed):** \[ \text{Monthly Revenue} = \text{Units Sold per Month} \times \text{Price per Unit} \] b) **Incremental Sales Volume:** \[ \text{New Sales Units} = \text{Current Units} \times (1 + \text{Sales Increase Percentage}) \] c) **Average Accounts Receivable (AR):** \[ \text{AR} = \text{Sales on Credit} \times \frac{\text{Collection Period in Days}}{30} \] *Note:* Since sales are on credit, the collection period affects AR. d) **Bad Debts Expense:** \[ \text{Bad Debts} = \text{Sales on Credit} \times \text{Bad Debt Percentage} \] e) **Additional Accounts Receivable (Incremental):** \[ \Delta AR = \text{AR (Proposed)} - \text{AR (Current)} \] f) **Cost of Capital on Additional Receivables:** \[ \text{Cost} = \text{Incremental AR} \times \text{Monthly Cost of Capital} \] where the monthly cost of capital = annual required return / 12. g) **Incremental Profit (Contribution Margin):** \[ \text{Contribution Margin per Unit} = \text{Sale Price per Unit} - \text{Variable Cost per Unit} \] \[ \text{Incremental Profit} = (\text{Incremental Units Sold} \times \text{Contribution Margin per Unit}) - \text{Additional Bad Debts} - \text{Additional Cost of Capital} \] --- **3. A Detailed Step-by-Step Solution** **Step 1:** Calculate current sales volume and revenue. - Current annual sales units: 10,500 units - Sale price per unit: $38 **Current annual revenue:** \[ 10,500 \times \$38 = \$399,000 \] **Current monthly revenue:** \[ \$399,000 / 12 = \$33,250 \] *Explanation:* The current scenario provides a baseline for revenue and sales volume, essential for comparison against the proposed credit extension. --- **Step 2:** Determine the projected sales units after relaxation of credit standards. - Sales are expected to increase by 10%: \[ 10,500 \times 1.10 = 11,550 \text{ units} \] **Projected annual revenue:** \[ 11,550 \times \$38 = \$438,900 \] **Projected monthly revenue:** \[ \$438,900 / 12 \approx \$36,575 \] *Explanation:* The increase in sales volume due to credit extension directly impacts revenue. This step quantifies the expected growth. --- **Step 3:** Calculate the increase in sales units and revenue attributable to credit extension. - Incremental units sold: \[ 11,550 - 10,500 = 1,050 \text{ units} \] - Incremental monthly units: \[ 1,050 / 12 \approx 87.5 \text{ units} \] - Incremental monthly revenue: \[ \$36,575 - \$33,250 = \$3,325 \] *Explanation:* These figures represent the additional sales attributable solely to the credit extension, providing the basis for incremental profit calculation. --- **Step 4:** Compute the accounts receivable under current and proposed policies. - **Current:** Since all sales are cash, AR = 0. - **Proposed:** Accounts receivable depends on the collection period (30 days) and sales on credit. \[ \text{Average AR} = \text{Sales on Credit} \times \frac{\text{Collection Period in Days}}{30} \] - **Sales on Credit (Proposed):** \[ \$438,900 \] - **Average AR:** \[ \$438,900 \times \frac{30}{365} \approx \$36,066 \] *(Alternatively, since the collection period is 30 days, AR is roughly 1/12 of annual credit sales):* \[ \text{AR} \approx \frac{\text{Annual Credit Sales}}{12} = \frac{\$438,900}{12} \approx \$36,575 \] *Note:* For simplicity, using the method based on 30 days: \[ \text{AR} = \text{Annual credit sales} \times \frac{30}{365} \approx \$36,066 \] *Explanation:* The AR reflects the funds tied up due to credit sales, which have cost implications and influence working capital requirements. --- **Step 5:** Calculate the additional bad debts resulting from the credit policy. - Bad debt percentage increases from 0% to 3%. - **Additional bad debts:** \[ \$438,900 \times 3\% = \$13,167 \] - **Bad debts attributable to incremental sales:** \[ \$13,167 \times \frac{\text{Incremental units}}{\text{Total units}} \approx \$13,167 \times \frac{1,050}{11,550} \approx \$1,200 \] *Explanation:* Bad debts reduce net profit; thus, the increase in bad debt expenses must be subtracted from the incremental contribution. --- **Step 6:** Calculate the contribution margin per unit. \[ \text{Contribution Margin} = \$38 - \$26 = \$12 \] - **Incremental contribution:** \[ 1,050 \text{ units} \times \$12 = \$12,600 \] *Explanation:* This represents the gross profit generated by the additional sales before considering bad debts and the cost of capital tied up in receivables. --- **Step 7:** Determine the cost of capital on additional accounts receivable. - **Monthly required return:** \[ \frac{1.2\% \text{ per month}} = 0.012 \] - **Additional AR:** \[ \$36,066 \] - **Monthly cost of capital:** \[ \$36,066 \times 0.012 \approx \$433 \] - **Annualized cost:** \[ \$433 \times 12 \approx \$5,196 \] *Explanation:* This cost reflects the opportunity cost of funds invested in receivables, reducing net incremental profit. --- **Step 8:** Calculate the net incremental profit. \[ \text{Net Incremental Profit} = \text{Incremental Contribution} - \text{Bad Debts} - \text{Cost of Capital} \] \[ = \$12,600 - \$1,200 - \$5,196 = \$6,204 \] *Explanation:* The net profit considers all relevant incremental revenues and costs, providing a comprehensive view of the financial impact. --- **Conclusion:** The analysis indicates that relaxing credit standards would generate an estimated **\$6,204** in additional monthly profit, after accounting for increased bad debts and the cost of capital tied up in receivables. Since this figure is positive, the proposal appears financially beneficial. However, it is important to consider other qualitative factors such as collection management and credit risk policies before final decision-making. --- **Summary:** Relaxing credit extends sales, increases receivables, and incurs additional bad debts and capital costs. The net impact, based on the calculations, shows a monthly incremental profit of approximately **\$6,204**, suggesting that offering credit can be a profitable strategy for Lewis Enterprises under the given assumptions.