The present credit term of X Ltd. are 1/10 net 30. Its annual sales are ₹40,00,000, its average collection period is 20 days. Its variable cost and average total costs to sales are 0.85 and 0.95 respectively and its cost

CS Executive · Financial and Strategic Management · PYQS · December 2018
The present credit term of X Ltd. are 1/10 net 30. Its annual sales are ₹40,00,000, its average collection period is 20 days. Its variable cost and average total costs to sales are 0.85 and 0.95 respectively and its cost of capital is 10%. The proportion of sales on which customers currently takes discount is 0.50. X Ltd. is considering relaxing the discount terms to 2/10 net 30. Such relaxation is expected to increase sales by ₹5,00,000, reduce the average collection period to 14 days and increase the proportion of discount sales to 0.80. What will be the effect of relaxing the discount policy on company's profit? Take year as 360 days.

Answer & Explanation:

Answer 2(d) Increase in Revenue = ₹5,00,000 Increase in contribution (₹5,00,000 * 15%) = ₹75,000 Investment in receivable Existing = (40,00,000 * 0.95 * 20) / 360 = ₹2,11,111 Proposed = ((40,00,000 * 0.95 + 5,00,000 * 0.85) * 14) / 360 = ₹1,64,306 Reduction in Investment x cost of capital = (₹2,11,111 - ₹1,64,306) * 0.10 = ₹4,681 Increase in discount Present discount = ₹40,00,000 x 0.01 x 0.5 = ₹20,000 Proposed discount = ₹45,00,000 x 0.02 x 0.8 = ₹72,000 Difference in discount = ₹52,000 Net effect on profit/loss = (₹75,000 + ₹4,681) - ₹52,000 = ₹27,681 Since, the proposed discount policy will increase the profits of the company by ₹27,681. Therefore, it is advisable for the company to relax the present discount policy.

Topics: Financial Management

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