Question

Question 3 [12] The credit rating agencies rated South Africa below investment grade, colloquially known as junk status. This implied that South Africa is less attractive to foreign direct investment. Meanwhile, businesses within the country are revising their own credit policy programs. Quarterly statistics released by Stats SA indicated a general decrease in sales from the following sectors: manufacturing, clothing and textile, and mining sector. The tum of events in the country prompted EDCON GROUP to produce new credit policy with the following credit terms: PROPOSED (NEW) TERMS OF CREDIT POLICY Sales R8 000 000 Variable costs 40% of sales Average collection period (ACP) 60 days Bad debts 5% of sales Discounts 20% discounts given on 40% of sales The following are the current terms of the credit policy: CURRENT TERMS OF CREDIT POLICY Sales R4 000 000 Variable costs 45% of sales Average collection period (ACP) 90 days Bad debts 6% of sales Discounts 30% discounts given on 60% of sales The business has a cost of capital of 10%. Required: Calculate the effect of the proposed policy on earnings before interest and tax (EBIT) and advise whether it will be better to switch to the new policy, or remain with the current one. (Assume a 365-day year).