Question

11:21 in O LT. 81% Read Only - You can't save changes to this file. From 2/10, net su LO 3/10, nel 30" Q4. The company has current sales of Rs. 30 crore. To push up sales, the company is considering a more liberal credit policy. The current average collection period of the company is 25 days. If the collection period is extended, sales increase in following manner. Credit policy Increase in collection period (days) Increase in sale (Rs. Lakhs) ΤΑ 15 12 25 35 47 The company is selling its product at Rs. 10 each. Average cost per unit at current level is Rs. 8 and variable cost per unit Rs. 6. If company's required rate of return is 12% on its investment then which credit policy is desirable? Q5. The credit terms of a firm currently is "net 30". It is considering to change it to "net 60". This will have the effect

11:21 in O LT. 81% Read Only - You can't save changes to this file. From 2/10, net su LO 3/10, nel 30" Q4. The company has current sales of Rs. 30 crore. To push up sales, the company is considering a more liberal credit policy. The current average collection period of the company is 25 days. If the collection period is extended, sales increase in following manner. Credit policy Increase in collection period (days) Increase in sale (Rs. Lakhs) ΤΑ 15 12 25 35 47 The company is selling its product at Rs. 10 each. Average cost per unit at current level is Rs. 8 and variable cost per unit Rs. 6. If company's required rate of return is 12% on its investment then which credit policy is desirable? Q5. The credit terms of a firm currently is "net 30". It is considering to change it to "net 60". This will have the effect

Please solve question 4

Answer 1

Q4. Please refer the below table:

Particulars	Source	Step Reference	Credit Policy
Current	A	B	C
Current Sales (Rs.)	Given in the question	(I)	300,000,000	300,000,000	300,000,000	300,000,000
Additional Sales (Rs.)	Given in the question	(II)	-	1,200,000	2,700,000	4,700,000
Expected Sales (Rs.)	Computed as given in 'Step Reference'	(III) = (I)+(II)	300,000,000	301,200,000	302,700,000	304,700,000
Selling price per unit (Rs.)	Given in the question	(IV)	10	10	10	10
Quantity Sold	Computed as given in 'Step Reference'	(V) = (III) / (IV)	30,000,000	30,120,000	30,270,000	30,470,000
Variable cost per unit (Rs.)	Given in the question	(VI)	6	6	6	6
Variable cost (Rs.)	Computed as given in 'Step Reference'	(VII) = (V) * (VI)	180,000,000	180,720,000	181,620,000	182,820,000
Contribution (Rs.)	Computed as given in 'Step Reference'	(VIII) = (III) - (VII)	120,000,000	120,480,000	121,080,000	121,880,000
Fixed Cost (Rs.)	Given in the question	(IX) - refer working # 1	60,000,000	60,000,000	60,000,000	60,000,000
Profit (Rs.)	Computed as given in 'Step Reference'	(X) = (VIII) - (IX)	60,000,000	60,480,000	61,080,000	61,880,000
Current Credit period (days)	Given in the question	(XI)	25	25	25	25
Incremental Credit period (days)	Given in the question	(XII)	-	15	25	35
Revised Credit period (days)	Computed as given in 'Step Reference'	(XIII) = (XI) + (XII)	25	40	50	60
Required rate of return	Given in the question	(XIV)	12%	12%	12%	12%
Less: Notional interest cost (Rs.)	Computed as given in 'Step Reference'	(XV) = (III)*(XIII)/365*(XIV)	2,465,753	3,960,986	4,975,890	6,010,521
Revised Profit (Rs.)	Computed as given in 'Step Reference'	(XVI) = (X) - (XV)	57,534,247	56,519,014	56,104,110	55,869,479
Incremental Profit / (Loss) over current profit		(XVII)	-	(1,015,233)	(1,430,137)	(1,664,767)

Workings:

# 1 Fixed Cost

Average total Cost per unit = Rs.8  

Variable Cost per unit = Rs.6

Fixed Cost per unit = Rs.8 - Rs.6 = Rs.2

Quantity sold currenty = 3 Crores

Total Fixed Cost = Rs. 3 crores * Rs.2 per unit = Rs.6 Crores (this remains same irrespective of change in volume)

Recommendation:

As can be seen in table (Step Reference - (XVII)any change from the current credit policy results in incremental loss to the company. Hence, ideally, no change is to be made. However, since the credit policy change is proposed to boost the sales, option A is to be chosen as under this option, the incremental loss is the lowest.