Inventory Management^257
discount rate of 12 percent to evaluate accounts receivable policy changes. How
would the change in credit terms affect Kalpana's after-tax income?Solution
To answer, first calculate the new and old investment in A/R
Old investment in A/R=(75 days)(Rs 50,000/day)(0.85) = Rs 3,187,500
New investment in A/R=(40 days)(Rs 48,000/day)(0.85) 1,632,000
D Investment in A/R Rs 1,555,500
There are three expected changes in after-tax net income:
D Financing cost of A/R investment = (Rs 1,555,500)(0.20) Rs 186,660
D Bad debt expense
[(0.05)(Rs 50,000)(365)-(0.03)(Rs 48,000)(365)](0.60) 232,140
D Profit on sales = (Rs 2000)(365)(0.15)(0.60) (65,700)
D Net Profit Rs 353,100- The Dryden Company currently offers trade credit to its customers on terms of
net 30. Daily credit sales average Rs 250,000 on which the company earns a
contribution margin of 25 percent. The average collection period of 45 days. The
company's marginal tax rate is 30 percent and its after-tax discount rate for
analyzing credit policy changes is 8 percent.
a. Under the current policies, what is the company's investment in accounts
receivable? What is the annual after-tax financing cost associated with the
investment in account receivable?
b. The company is considering offering credit terms of 2/10, net 30. If the
discount is offered, an estimated 85 percent of the company's customers will
choose to take the discount and the average collection period will fall to 18
days. Assuming the change in credit policy has no effect on daily sales, what
will be the effects on the company's after-tax net income?
c. Suppose the change in credit terms also reduces daily sales by Rs 4,000,
lowers bad debt expenses from 5 percent to 2 percent of sales, and saves Rs
60,000 per year in credit department expenses. Will it be profitable to change
the credit terms?
Solution
a. Under current policies:
Investment in A/R=(Rs 250,000)(0.75)(45 days) = Rs 8,437,500
Cost of financing A/R = (Rs 8,437,500)(0.08) = Rs 675,000