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.

the company can earn an additional $488.80 on interest

Explanation:

total sales on credit = $167,500

interest rate = 8%

accounts receivable = $18,500

sales per day = $167,500 / 365 days = $458.90 per day

days sales outstanding (DSO) = ($18,500 / $167,500) x 365 days = 40

average industry DSO = 27 days

to determine the value of accounts receivable to match the industry's DSO:  (AR / $167,500) x 365 = 27

AR = 27 x ($167,500 / 365) = $12,390

So accounts receivable must lower by ⇒ $18,500 - $12,390 = $6,110

that $6,110 should earn 8% interest = $6,110 x 0.08 = $488.80

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