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?
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

c. $488.77

Explanation:

Step 1: Calculate Accounts Receivable for Industry DSO

The accounts receivable for industry DSO is calculated as below:

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

Step 2: Calculate Value of Freed-Up Cash

The value of freed-up cash is determined as below:

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

Step 3: Calculate Effect of Net Income

The effect on net income is calculated as below:

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

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