Home Depot expects sales of $20 million this year under the
current credit policy. The present credit terms is net 30 but the
DSO is actually 45 days, and the bad debt loss is 3% of
sales. Also, Home Depot’s cost of capital is 10%, and its
total variable costs is running at 70% of sales. Since Home Depot
wants to improve its profitability, the Finance Manager is
proposing to change the credit term to 2/15, net 30. The Finance
Manager predicts that sales would increase by 10% as a result and
that 75% of all customers would take advantage of the new discount
with the rest paying on time. The bad debt loss would fall to
1%. Should the Finance Manager’s proposal be accepted?
How much would the pre-tax profits change before and after this
You must show all calculation steps, providing a final
answer only will not get you full marks.