Question

Bright Limited is a manufacturer of garden chairs and is considering
relaxing its tight credit policy to boost sales in the light ot the current market
development. The change in policy will result in an inerease n average collection
period from 30 days (1 month) to 60 days (2 months). The review in credit policy is
expected to increase sales in each year amounting to 25% of the current sales volume.
Seling price unit GHe30Variable cost per unit GHE27
Current anual sales GHe6,000.000
The 25% increase in sales will result in additional stock level of GHe250,000 and
additional accounts payable of GH¢50,000. The required rate of return on the investment is
25%.
Required:
Provide your advise on whether to extend or not extend period tocustomers if:
() All the customers take the longer credit of 2 months.
(11) Existing customers do not change their payment terms and only thenew ones did?

Answer 1

1. All the customers take the longer credit of 2 months ( all amounts in Ghe)

Total sale including additinal sales = 62,50,000

Less variable cost ( 62,50,000/ 30)* 27 = 56,25000

Contribution =6,25,000

Contribution per unit = 6,25,000/208334= 3 (aaproximately)

Therfore additional contribution due to increase in credit period =( 2,5000030) * 3 =25,000

A.Proposed investment in debtors = 62,50,000* 60/365 =10,27,397

B. Current investent in debtors = 60,00,000* 30/365 =4,,93,150

Therfore additional investment in debtors (A-B) =5,34,247

additional finance cost = 5,34,247 * 25% = 1,33,562

additional finance cost is more than the additional contribution therfore increasing credit to all customers is not advisable

2)

Existing customers do not change their payment terms and only the new ones did

Increased contribution ( calculated above) = 25,000

Inreased finance cost

Additional sales = 2,50,000

rate of return on the investment is =25%.

A.Proposed investment in debtors = (60,00,000* 30/365) + (2,50,000* 60/365) = 5,34,247

B. Current investent in debtors = 60,00,000* 30/365 =  4,,93,150

Therfore additional investment in debtors (A-B)    =41,097

additional finance cost = 41,097 * 25% = 10,274

In the second case additiobnal contribution is more than the additional finance cost so therefoe it is advisable to increase the credit period only to new customers , while the same credit period of 30 days should be maintained for the old customers

Option Two is advisable