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A company is considering increasing its credit period to customers from one month to two months.Annual revenue is currently $1200000.It is expected that the increased credit period would increase sales by 25% and result in an increase in profit of $45000,before any INCREASE in finance charges have been taken into account.The company’s cost of capital is 10%
What is the financial effect of this proposal after taking into account any increase in finances charges?
C.Increase in profit of $30000
D.Decrease in profit of $30000My answer is:
New receivables:
2/12 × 1500000 = 250000Current receivables:
1/12 × 1200000 = 100000Increase in receivables = 150000
~Therefore,if increase in receivables give rises to the interest cost, to finance the receivables
Interest cost : 10% × 150000 = $15000
Impact on the profit:
Profit – minus interest cost of receivables
: 45000-15000
$30000My answer is D
But the answer given was CYour workings are correct, but your final conclusion isn’t!
The profit increases by 45,000 due to the extra sales. The profit reduces by 15,000 due to the extra interest.
So there is a net increase in profit of 30,000.
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