Final answer:
Mansor Carpet Repairs should not relax its credit standards as the net cost of doing so exceeds the required rate of return of 15% on investments.
Step-by-step explanation:
To determine whether Mansor Carpet Repairs should relax its credit standards, we need to evaluate the potential impact on the company's financials. Currently, the company repairs 60,000 carpets per year at an average price of RM30 each, resulting in total sales of RM1,800,000. The bad debt expense is 2% of sales, which amounts to RM36,000. The average collection period is 45 days, and the variable cost per unit is RM26.
If credit standards are relaxed and sales increase by 6,000 repairs per year, the new total sales would be RM1,980,000. However, bad debts would increase to 3% of sales, amounting to RM59,400. The average collection period would also increase to 55 days. We need to assess whether the benefits of increased sales outweigh the higher bad debt expense and longer collection period.
To make a recommendation, we can calculate the net cost of relaxing credit standards. The additional bad debt expense is RM23,400 (RM59,400 - RM36,000), and the carrying cost for the longer collection period can be calculated using the formula:
Carrying cost = (Average collection period / 365) * (Variable cost per unit * Additional repairs per year)
The carrying cost would be RM4,777.81. Therefore, the total net cost of relaxing credit standards would be RM28,177.81 (RM23,400 + RM4,777.81).
To assess whether the firm should relax its credit standards, we need to compare the net cost to the firm's required rate of return on investments, which is 15%. If the net cost is higher than the required rate of return, the firm should not relax its credit standards.
In this case, the firm should not relax its credit standards, as the net cost of RM28,177.81 is higher than the required rate of return of 15%. It would be more financially beneficial for the company to maintain its current credit standards.