3. Change in credit policy. The Manila Company presently gives terms of net 30
days. It has P60 million in sales, and its average collection period is 45 days. To
stimulate demand, the company may give terms of net 60 days. If this policy is
implemented, sales are expected to increase by 15%. After the change, the average
collection period is expected to be at 75 days, with no difference in payment habits
between old and new customers. Variable cost are P0.80 for every P1.00 of sales,
and the companys required rate of return on investment in receivables is 20%. The
company expects to spend an incremental cost collection cost of P200,000 to
undertake this change in credit policy. The prevailing average market rate of
investment is 15% per annum. Customers default in payments are expected to
reach 3% on total sales as compared from a minimal 1.5% based on the present
credit terms.
Required: Should the company extend its credit period? (Answer a 360-day year.)
Before After
Sales P60M P69M (P60Mx115%)
Collection period 45 days 75 days
Receivable Turnover 8x 4.8x
(360 days/ collection period)
A. Receivable Balance P7.5M P14.375M
(Sales/Rec. Turnover)
Bad Debts P900,000 P2.070M
(1.5% x P60M) (P69M x 3%)
Incremental CM (P9M x 80%) P7,200,000
Opportunity cost [(P14,375,000 P7,500,000) x 80% x 20%] (P1,100,000)
Increase in bad debts (P2,070,000 P900,000) (P1,170,000)
Increase in collection costs (P200,000)
Incremental IBIT P4,730,000
The company is advised to extend its credit period and increase its income before
income tax of P4.73 million.
5. Cost of collection efforts. Dream Corporation spends P220,000 per annum on its
collection department . The company has P12million in credit sales. Its average
collection period is 2.5 months, and the percentage of bad debts loss is 4 %. The
company believes that if it were to double its collection personnel, it could bring
down the average collection period to 2 months and bad debt losses to 3 percent.
The added cost if P180,000, bringing total expenditures to P400,000 annually.
Required: Is the increased effort worthwhile if the opportunity cost of funds is 20%?
If it is 10%?