Question 5
Extending credit from one month to two; the never-delinquent credit department
18.75 marks
- Time to write
- About 38 minutes
From an older CBCS paper
Question
Question 5 · 18.75 marksQ5. A company's products are sold @ Rs. 30 per unit, and their variable cost is Rs. 20 per unit. Its fixed cost amounts to Rs. 7,50,000 per annum, and its total annual sales to Rs. 90,00,000. Sales are estimated to rise by Rs. 7,20,000 per annum if the present credit facility is extended from one month to two months. The company's expected minimum return is 20%. Advise whether this course can be adopted.
Also evaluate this statement: "A credit department which never has a delinquent account is an asset to the firm".
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Advise…Evaluate…Two asks in one question: answer both.
- evaluateA statement to judge: take a stand on it in your first line, and come back to it at the end.
- evaluateBoth sides: the strengths, the limits, then your own view.
- AdviseEnd with a one-line decision that follows from your figures.
What the paper leaves open
No mark is printed for the question; the paper asks for any four of six, equal marks.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Investment in debtors at cost, present and proposed 5 marks 9 min
- 2 Extra contribution, required return, net gain and advice 6 marks 11 min
- 3 Evaluation of the statement 7.8 marks 14 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 38 minutes for 18.75 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Part 1: should credit be extended to two months? Units sold now = 90,00,000 ÷ ₹30 = 3,00,000; extra sales ₹7,20,000 = 24,000 units. The investment in debtors is taken at total cost (variable plus fixed) × credit period. Fixed cost is unchanged; no bad debts are given.
| Particulars (₹) | Present (1 month) | Proposed (2 months) |
|---|---|---|
| Sales | 90,00,000 | 97,20,000 |
| Variable cost (₹20 a unit) | 60,00,000 | 64,80,000 |
| Fixed cost | 7,50,000 | 7,50,000 |
| Total cost | 67,50,000 | 72,30,000 |
| Investment in debtors at cost (total cost × months ÷ 12) | 5,62,500 | 12,05,000 |
- Extra contribution = 24,000 units × (30 − 20) = ₹2,40,000.
- Extra investment in debtors = 12,05,000 − 5,62,500 = ₹6,42,500; required return @ 20% = ₹1,28,500.
- Net gain = 2,40,000 − 1,28,500 = ₹1,11,500.
Advice: adopt the two-month credit, since the extra contribution exceeds the cost of the extra funds blocked in debtors (subject to bad debts not rising materially).
Part 2: "A credit department which never has a delinquent account is an asset to the firm." Not necessarily. A record of no bad or overdue accounts usually means credit is granted only to the safest customers, with a very short period: the policy is too tight. Credit terms are set to win and keep customers, and a firm that allows less credit than its competitors loses sales to them. The cost of lost contribution may far exceed the bad debts avoided, as Part 1 shows: liberal credit added ₹1,11,500 here. The right aim is the credit policy that maximises net benefit, balancing extra contribution against bad debts and the cost of funds in receivables, which normally means accepting some delinquent accounts. A department with none is probably costing the firm profit.
Where the 18.75 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Investment in debtors at cost, present and proposed | 5 |
| 2 | Extra contribution, required return, net gain and advice | 6 |
| 3 | Evaluation of the statement | 7.75 |
| Total | 18.75 |
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