- 15 Marks
Question
Adjaye Ltd has current sales of GH¢1.5 million per year. Cost of sales is 75% of sales and bad debts are 1% of sales. Cost of sales comprises 80% variable costs and 20% fixed costs, while the company’s required rate of return is 12%. Adjaye Ltd currently allows customers 30 days credit, but is considering increasing this to 60 days credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15% and bad debts will increase from 1% to 4%. It is not expected that the policy change will result in an increase in fixed costs, and creditors and stock will be unchanged.
Required:
Advise whether Adjaye Ltd should introduce the proposed policy. Support your answer with relevant computations.
Answer
New level of sales will be 1,500,000 x 1.15 = ¢1,725,000
Variable costs are 80% x 75% = 60% of sales
Contribution from sales is therefore 40% of sales
Decision
The financing policy is financially acceptable, although the savings are not great.
- Tags: Accounts Receivable, Bad Debts, Credit Policy, Financing Costs, Working Capital
- Level: Level 2
- Topic: Working Capital Management
- Series: MAY 2018
- Uploader: Joseph