Question

Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and it gives its customers 25 days to pay. The industry average DSO is 27 days, based on a 365-day year.If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant

Answer 1

c. $488.77

Step-by-step explanation:

Incomplete question "Assume all sales to be on credit. Do not round your intermediate calculations. Hint: focus on the DSO to figure out how much freed-up cash the company will have. Freed-up cash will be invested at 8%. a. $386.13 b. $601.18 c. $488.77 d. $562.08 e. $537.64"

Accounts Receivable (Industry DSO) = Sales Value*Industry Average DSO/Total Days in the Year

Using the values provided in the question in the above formula, we get, Accounts Receivable (Industry DSO) = 167,500*27/365 = $12,390.41

Freed-Up Cash = Value of Accounts Receivable at Company's DSO - Value of Accounts Receivable for Industry Average = 18,500 - 12,390.41 = $6,109.59

Effect on Net Income = Freed-Up Cash*Rate of Return = 6,109.59*8% = $488.77.