The current credit sales of a firm is ₹ 20,00,000 and the firm still has an unutilized capacity. In order to boost its sales, the firm is willing to…

Evaluation of Credit Policies Particulars Present Policy (₹) Proposed Policy (₹) Credit Sales 20,00,000 23,00,000 (115% of 20,00,000) Variable Cost (75%) (15,00,000) (17,25,000) Contribution 5,00,000 5,75,000 Bad Debts (30,000) (20,00,000 × 1.5%) (57,500) (23,00,000 × 2.5%) Profit Before Tax (PBT) 4,70,000 5,17,500 Tax @ 30% (1,41,000) (1,55,250) Profit After Tax (PAT) 3,29,000 3,62,250 Opportunity Cost (Refer working note) (22,500) (34,500) Net Profit 3,06,500 3,27,750 In the proposed scheme the net profit is more by ₹ 21,250 i.e. (₹ 3,27,750 – ₹ 3,06,500), hence, the company should change the credit policy. Working Note: Opportunity Cost on Investment in Debtors: Present policy = Variable Cost × (Collection period / 360) × Required rate of return = 15,00,000 × 45/360 × 12% = ₹ 22,500 Proposed policy = 17,25,000 × 60/360 × 12% = ₹ 34,500 Assumptions: (i) Cash discount is not availed by the debtors. (ii) Debtors are utilising the full credit period for payment. (iii) Number of days in a year is 360 days.