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BPP Example: chapter 5: Extension of credit

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › BPP Example: chapter 5: Extension of credit

  • This topic has 3 replies, 2 voices, and was last updated 10 years ago by John Moffat.
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  • July 27, 2014 at 12:11 am #179755
    nari
    Member
    • Topics: 261
    • Replies: 176
    • ☆☆☆

    E Co currently expects sales of $50,000 a month. VC of sales are $40,000 a month. If cr period increased for 30 days to 60 days , sales volume would increase by 20%. All customers would take advantage of the extended credit. If cost of capital is 12.5% a year, is the extension of credit justifiable?

    BPP Answer:
    increase in AR= 120,000-50,000=$70,000
    financing = 70,000x 12.5%= $8,750
    annual contribution= 12 months x 20% x $10,000=24,000
    annual net benefit of extending credit= 24,000-8,750=15,250

    what i do not understand:
    the increase in AR of 70,000 is over a 2 month period (60 days), however the financing of 12.5% is for a whole year. Therefore I was thinking that it would have been [70,000 x 12 months /2] x 12.5%

    Please explain. Thanks.

    July 27, 2014 at 8:43 am #179762
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54664
    • ☆☆☆☆☆

    It is because the new average receivables will be 120,000 all year – i.e. they will be on average 70,000 higher throughout the year.

    So the extra 70000 working capital needs financing throughout the year, not just for two months.

    (You might find it useful to watch my free lecture on this)

    July 27, 2014 at 5:15 pm #179779
    nari
    Member
    • Topics: 261
    • Replies: 176
    • ☆☆☆

    Thanks john

    July 27, 2014 at 5:38 pm #179782
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54664
    • ☆☆☆☆☆

    You are welcome Nari 🙂

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