(^258) Financial Management
Risk
Class
Average
Collection
period
Annual sales Bad debts as
percentage of sales
Additional annual credit
department expenses
4
5
50 days
65 days
730,000
580,000
7%
12
Rs 35,000
62,000
b. The new investment in accounts receivable will be
D Investment in A/R = (Rs 250,000)(0.75)(45-18) = Rs 5,062,500
The changes in after-tax income are:
D Cost of financing A/R=(Rs 5,062,500)(0.08) Rs 405,000
Discounts accepted (0.02)(Rs 250,000)(0.85)(365)(0.60) (930,750)
D NIAT (Rs 525,750)
The proposed policy changes would be unprofitable.
c. The change in the investment in A/R is:
New investment in A/R=(18)(Rs 246,000)(0.75) Rs 3,321,000
DInvestment in A/R = (Rs 3,321,000 - 8,437,500) - Rs 5,116,500
The changes in after-tax income are:
D Cost of financing A/R = (-5,116,500)(0.08) Rs 409,320
Lower profit on sales = (Rs 4000)(365)(0.25)(0.60) (219,000)
Discounts accepted = (0.02)(246,000)(365)(0.60) (1,077,480)
D Bad debt expense
=(0.05)(250,000)(365)-(0.02)(246,000)(365) 1,660,020
D Credit department expenses = (0.60)(Rs 60,000) 36,000
D Net Profit Rs 808,860
The change in credit policies would be profitable.
- The Superb Company is evaluating its credit standards. The company's variable
cost ratio is 78 percent of sales and its marginal tax rate is 40 percent. The
appropriate after-tax discount rate for evaluating credit policies is 9 percent. Superb
classifies customers into several credit classes depending on the risk of default.
Based on the information given in the table, would Superb be better off not granting
credit to the two customers in risk classes 4 and 5? (Evaluate the profitability of
granting credit to each risk class separately.)