4 4) RM :A company is presently having credit sales of ` 12 lakh. The existing credit terms are 1/10, net 45 days average collection period is 30 days. The current bad debts loss is 1.5%. in order to accelerate the collection process further as also to increase sales, the company is contemplating liberalization of its existing credit terms to 2/10, net 45 days. It is expected that sales are likely in increase 1/3 of existing sales, bad debts increase to 2% of sales and average collection period to decline to 20 days. The contribution to sales ratio of the company is 22% and opportunity cost of investment in term of sales revenue are expected to avail cash discount under existing and liberalization scheme respectively. The tax rate is 30%. Should the company change its credit terms? (Assume 360 days in a year).

Solution:

Evaluation of discount policy

Particulars                                           Amount in Rs.

(A) Contribution on additional sales = 12 Lac × 1/3 * 22%  = 88,000

(B) Saving of interest

Under existing situation 12L × 78 % × 30/360= 78,000

After change in policy 16L × 78 % ×20/260= 69,333

Decrease in COD                                                              8,667

Saving of Interest @ 15 %                                             1,300

(C) B. Debts

Current 12 Lac × 1.50%   = 18,000

After 16 Lac × 2%              = 32,000               (14,000)

(D) Cash Discount           

Current 12L × 50% × 1%                 = 6,000

After 16L × 80% × 2%      = 25,600               (19,600)

Net Benefit before tax                                  55,700

Less: Income Tax @ 30%                               16,710

Net Benefit                                                        38,990

Note: Saving of Interest is calculated on cost of debtors

2  5)  A new customer with 10% risk of non-payment desires to establish business connections with you. He would require 1.5 month of credit and is likely to increase your sales by ` 1, 20,000 p.a. Cost of sales amounted to 85% of sales. The tax rate is 30% Should you accept the offer if the required rate of return is 40% (after tax)?

Solution:

Additional sales from new customer p.a. 1,20,000

- Risk of non-payment @ 10% 12,000      1, 08,000

- Cost of sale (85% × 1,20,000)                   1,02,000

PBT                                                                                        6,000

- Tax @ 30%                                                                        1,800

PAT                                                                                        4,200

Avg. Investment in Return= 1,02,000 ∗ 1.5/12 = 12,750

Rate of return   = 4200/ 12750 * 100 = 32.94%

The offer should not be accepted.