Inventory Management^259
Solution
For each risk class, the net advantage of granting credit is:
Risk class 4:
Profit on sales = (Rs 730,000)(0.22)(0.60) Rs 96,360
Bad debt expense = (Rs 730,000)(0.07)(0.60) (30,660)
Cost of financing A/R=(Rs 730,000/365)(50 days)(0.09) (9,000)
Extra credit department costs (Rs 35,000)(0.60) (21,000)
D NIAT Rs 35,700
Risk class 5 :
D Profit on sales = (Rs 580.000)(0.22)(0.60) Rs 76,560
D Bad debt expense = (Rs 580,000)(0.12)(0.60) (41,760)
Cost of financing A/R=(Rs 580,000/365)(65 days)(0.09) (9,296)
Extra credit department costs (Rs 62,000)(0.60) (37,200)
D Net Profit -Rs 11,696
Extending credit to risk class 5 appears unprofitable.- The Sunit Company currently carries Rs 12 million of inventory. The finance
manager proposes a reduction in inventory to Rs 10 million. The sales and
production managers estimate that the policy change will increase stockouts, costing
the company sales of Rs 600,000 per year. Storage and spoilage costs should
decrease by Rs 25,000 per year and the company's investment in accounts
receivable will decrease by Rs 120,000. The variable cost ratio is 75 percent of
sales. The company's marginal corporate tax rate is 30 percent and the appropriate
after-tax discount rate for evaluating inventory policy changes if 8 percent.
a. What are the financing costs to the company of its current inventory policies?
b. If the new policy is adopted, what will be the annual change in after-tax
income?
Solution
a. Financing cost of inventory = (12 million)(0.08)=Rs 960,000 per year.
b. The policy changes will have the following effects on annual income.
D Financing of inventory = (Rs 2,000,000)(0.08) Rs 160,000
D Stockout and spoiling cost = (Rs 25,000)(0.60) 15,000
D Financing of A/R = (Rs 120,000)(0.08) 9,600
D Profit on sales = (Rs 600,000)(0.25)(0.60) (90,000)
D Net Profit Rs 94,600