Corporate Finance

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Corporate Finance

Total new investment in receivables = Increase in receivables x Cost of capital

= 5.2 × 0.16 = Rs 0.832 crore

Since additional profit (Rs 2 crore) is greater than additional cost of maintaining receivables, the lengthening

of credit period should be considered. FABR extends a credit period of 15 days. But as competition becomes

intense, FABR is forced to give longer credit periods.

CASH DISCOUNT

The purpose of offering cash discount was briefly discussed earlier. A credit term of 1/10, Net 30 implies that
1 percent discount is offered if the payment is made by the 10th day—otherwise the payment is due by the
30th day. The benefits of offering higher discount are:

• Customers may pay up early to avail cash discount. So the cost of maintaining receivable decreases.


• Additional sales may be generated resulting in profits.

The costs are:

• Additional cash discount to be paid.


• Additional investment in receivables arising out of new sales.

If a company’s cost of capital is 16.5 percent, the average credit sales is Rs 10 crore.

The terms of sale are: 2/10 Net 45.

The seller will receive:

a) Rs 10 crore less discount of 2 percent on day 10; or
b) Rs 10 crore on day 45.

The PV of (a) is:

(1[ 10 / 365 .0) 165 ]

10 crore (1–0.02)

+ × = Rs 9.756 crore (1)

The PV of (b) is:

(1[ 45 / 365 .0) 165 ]

10 crore

+ × = Rs 9.8 crore (2)

Net benefit = (2) – (1)

= Rs 0.044 crore

Consider an extended example:

Current sales = Rs 100 crore

Current credit policy = 1/10, Net 30