Question

XYZ corp is re-evaluating its credit policy. Current terms are 2/10, net 30, resulting in annual sales of 900,000 units. Cash sales that qualify for the discount account for 10 percent of sales, 45 percent qualify for the discount by paying on the 10th day, and the other 45 percent pay, on average, in 40 days. Unit sales price is $24.00 and variable production costs are $18.00 per unit. Bad debts are 1.5 percent of credit sales.

The new policy of 2/10, net 60 is expected to increase sales by 15 percent annually. Cash sales are expected to remain at 10 percent of sales, but those qualifying for the discount by paying in10 days would drop to 25 percent; the other 65 percent would, on average, pay in 80 days. It is expected that variable production costs would remain at $18.00 per unit but that bad debt expense would increase to 2.5 percent of credit sales. XYZ corps’ banker would continue to finance working capital requirements at 12 percent.

Answer 1

Cost to the company due to old credit policy

Particulars	Old Credit Policy
Annual Sales	900,000
Units Sales Price	$                        24
Revenue from sale of goods	$          21,600,000
Less- Variable cost	$          16,200,000
Gross profit	$            5,400,000
Payment Discount provided to customer on payment within 10 days	$               194,400
Interest cost for 10 days for 45% customers if they pay on 40th day (45% - 1.5%) = 43.5%	$            30,890.96
Bad debt expenses	$            291,600.0
Total cost for the Company	$               516,891

Cost to the company in new credit policy

Particulars	New Credit Policy
Annual Sales	1,035,000
Units Sales Price	$                        24
Revenue from sale of goods	$          24,840,000
Less- Variable cost	$          18,630,000
Gross profit	$            6,210,000
Payment Discount provided to customer on payment within 10 days	$               124,200
Interest cost for 50 days for 62.5% customers if they pay on 80th day (65% - 2.5%) = 62.5%	$          255,205.48
Bad debt expenses	$            558,900.0
Total cost for the Company	$               938,305

Cost of the Company will increase in new credit policy, so it not viable for the company.