Question

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

c. Should Henderson liberalize credit if a 16 percent after-tax return on investment is required?

Short answer

The company should liberalize its credit policy.

Step-by-step solution

Meaning of credit policy

The credit policy is the rules and policies that the company has to follow before granting credit to any customer. This policy is designed to ensure that the credit risk of the company is reduced and they are able to timely collect the receivables.

Credit policy should be liberalized

The company requires a rate of return of 16% but it currently has a rate of return of 35.2%. So, the liberalization of the credit policy will not have any severe impact on the company’s ROI.