Analyzing a change in credit policy: Existing Policy: • 1/10 net 40 where 50% take the...

Analyzing a change in credit policy:

Existing Policy: • 1/10 net 40 where 50% take the discount; 50% pay on 40th day • Sales: $ 6 million/year; Bad debts: 2% of sales

Proposed Policy: • 2/10 net 50 where 70% are expected to take the discount; 30% expected to pay on 50th day • Expected sales: $ 7 million/year; Bad Debts (expected): 4% of sales Additional information: The companies variable costs are 60% of sales under both policies; Fixed costs are $1 million. Cost of funds remains 12%; Corporate tax rate: 30%.

a) Should the proposed policy be implemented? Justify your recommendation

b) What is the EAR of existing accounts receivable policy?

c) Would you advise the company to eliminate all trade credit if it resulted in a drop of sales to $5 million? Why or why not?

Expert Solution

a)It is better to implement the new proposal of 70m sales , since will increase net income up to $183836

b) EAR for existing proposal =(incremental expected profit/Incremental investment receivable)*100

so EAR =(183836/98630)

=18.63

C)If company eliminate trade policy if sales drop into 5million there will be a loss of revenue(1250000-1039452)210548. so in that case company can stick on present policy

Workings

Particulars	Present policy	Proposed policy1	Proposed policy 2
Sales revenue( A)	6000000	7000000	5000000
less; variable cost(60%) (B)	3600000	4200000	3000000
Fixed cost (C)	1000000	1000000	1000000
Discount (D)	30000(1%)	98000(2%)
Receivables	(6000000(40/365)50% 328767	(7000000(40/365))30% 230137
Reduction in Recievable from present level		98630	328767
Saving in interest @12%(98630*12%)(E)		11836	39452
% of bad debts loss	2% on sales	4% on sales
bad debt (F)	120000	280000
Net Income(A+E)-B-C-D-F	1250000	1433836	1039452

jeff jeffy answered 1 year ago

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