Precision Tools Ltd. currently has sales of ₹30,00,000 with an average collection period of two months. At present, no discounts are offered to the customers. The management of the company is thinking to allow a discount

Evaluation of Cash Discount Proposal Given Information: Current Sales = ₹30,00,000 Current Average Collection Period = 2 months Proposed Discount = 2% on cash sales Proposed Average Collection Period = 1 month Percentage of customers taking discount = 50% Required Return on Investment = 25% 1. Calculate Current Debtors: Current Debtors = Sales × (Average Collection Period / 12 months) Current Debtors = ₹30,00,000 × (2 / 12) = ₹5,00,000 2. Calculate Debtors under New Proposal: Debtors under New Proposal = Sales × (New Average Collection Period / 12 months) Debtors under New Proposal = ₹30,00,000 × (1 / 12) = ₹2,50,000 3. Calculate Reduction in Investment in Debtors: Reduction in Debtors = Current Debtors - Debtors under New Proposal Reduction in Debtors = ₹5,00,000 - ₹2,50,000 = ₹2,50,000 4. Calculate Savings from Reduced Investment in Debtors: Savings = Reduction in Debtors × Required Return on Investment Savings = ₹2,50,000 × 25% = ₹62,500 5. Calculate Cost of Discount: Cost of Discount = Sales × Percentage of customers taking discount × Discount Rate Cost of Discount = ₹30,00,000 × 50% × 2% Cost of Discount = ₹30,00,000 × 0.50 × 0.02 = ₹30,000 6. Calculate Net Increase in Profit: Net Increase in Profit = Savings from Reduced Investment - Cost of Discount Net Increase in Profit = ₹62,500 - ₹30,000 = ₹32,500 Advice to Management: Since the net increase in profit is ₹32,500 (a positive value), it is advised to offer the 2% discount on cash sales. This policy will lead to an overall increase in the company's profitability.