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Q. Russian Beard Co is considering a change of credit policy which will result in an increase in the average collection period from one to two months. The relaxation in credit is expected to produce an increase in sales in each year amounting to 25% of the current sales volume.
selling price per unit $10
variable cost per unit $8.50
current annual sales $2,400,000
The required rate of return on investment is 20%. Assume that the 25% increase in sales would result in additional inventories of $100,000 and additional accounts payable of $20,000.
Advise the company on whether or not to extend the credit period offered to customers, if:
(a) All customers take the longer credit of two months
(b) Existing customers do not change their payback habits and only the new customers take a full two months credit.Sir please help me how to find the contribution for this problem
Contribution is selling price less variable cost, so in this case the contribution is $1.50 per unit.
Yes, I know how to solve it, but rather than just expecting me to produce an answer (especially since presumably you have an answer in whichever book you found the question) it is better if you say which part of the answer is causing you a problem and then I will try and help you.
(I do assume that you have watched the free lecture on managing receivables?)
Yes sir i have watched the lecture.
(a) Extra investment, if all accounts receivables take two months creditAverage account receivable after the sales increase (2/12 x $3,000,000 ) 500,000
Doubts
1.) is why have the taken average account receivable?
2.) increase in sales revenue is 600,000 so average of 600,000 should be 300,000We take the average because we are trying to calculate the interest cost over the year. As receivables are higher or lower, so too will be the interest, so we use the average receivables.
Sales revenue is not the same as receivables!!!
As an example: if revenue for the year is $1.2M then we are selling $100,000 a month. So if receivables take 2 months to pay then average receivables will be $200,000.sir i did not understand still how they got 3,000,000 :(..As you said sales revenue is not the same as receivables but in the question they have not given how much is the receivables
solution :
The change in credit policy is justifiable if the rate of return on the additional investment in working capital would exceed 20%
Extra profit
contribution/sales ratio 15%
increase in sales revenue $600,000
increase in contribution and profit $90,000
(a) Extra investment, if all accounts receivables take two months credit $
Average accounts receivables after the sales increase (2/12 x $3,000,000) 500,000
Less current average accounts receivables (1/12 x $2,400,000) 200,000
Increase in account receivables 300,000
Increase in inventories 100,000
_______
400,000
less increase in account payable 20,000
Net increase in working capital 380,000Return on investment $90,000
________
$380,000
= 23.7%You are expected to calculate the receivables – in exactly the same way as I do in the lecture!!
The new sales revenue is 2,400,000 + 25% which is 3,000,000.
Receivables will take 2 months credit, and so the new receivables figure is 2/12 x $3,000,000 = $500,000.sir new sales revenue is 600,000 rite? so average of 600,000 is 300,000 rite sir?
The question says that the revenue increases by 25%.
25% of 2,400,000 is 600,000.
Therefore the new sales revenue is 2,400,000 + 600,000 = 3,000,000Even if it was 600,000 (which it is not), I have absolutely no idea why you want to take the average of it!!
if customers take 2 months credit, then the average receivables are 2/12 x 3,000,000 = 500,000.
There are two lectures on managing receivables, and dealing with this kind of question is dealt with in the second one. I cannot believe you have watched this lecture – if you have, then you really should watch it again.
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