Question 4 OR (b)
Choosing among credit policies
7 marks
- Time to write
- About 14 minutes
From an older CBCS paper
Question
Question 4 OR (b) · 7 marksD Ltd's management is considering changing its present credit policy the options' details are as follows:
| Credit Policy | Present | POLICY I | POLICY II | POLICY III |
|---|---|---|---|---|
| Sales | ₹1,20,000 | ₹1,34,400 | ₹1,44,000 | ₹1,48,800 |
| Variable Cost (% of Sales) | 80% | 80% | 80% | 80% |
| Fixed Cost | ₹14,400 | ₹14,400 | ₹14,400 | ₹14,400 |
| Average Collection Period. | 30 days | 45 days | 60 days | 75 days |
Rate of Investment for the firm: 20%. Assuming a year of 360 days Advise which option is best.
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
- Assuming a year of 360 days…The paper fixes this: use it as given, and say so in your answer.
- AdviseEnd with a one-line decision that follows from your figures.
What the paper leaves open
"Rate of Investment" is read as the required rate of return on investment (20%). Investment in debtors is valued at total cost.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Costs and profit under each policy 2½ marks 4 min
- 2 Investment in debtors and required return 3 marks 5 min
- 3 Net benefit and advice 1½ marks 3 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Short on time? End with step 3's one-line decision, whatever happens: never leave the figures without it.
Try it first. About 14 minutes for 7 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.
Basis (paper note). The investment in debtors is valued at total cost: total cost × collection period ÷ 360; the required return on it is 20%. A longer credit period raises sales but also the investment in receivables; credit is extended only as far as the extra profit exceeds the extra cost.
1'Pay next month'—the boxes fly off the van and every arm in the lane is full.
Consequences of lengthening the credit periodHigher sales and profit; larger investment in receivables; more bad debts and collection costs.
2Cash on delivery only: fewer takers at the door, but the money is in hand today.
Consequences of shortening the credit periodLower investment in receivables and better liquidity; possible loss of sales and profit.
| Particulars (₹) | Present | Policy I | Policy II | Policy III |
|---|---|---|---|---|
| Sales | 1,20,000 | 1,34,400 | 1,44,000 | 1,48,800 |
| Variable cost (80%) | 96,000 | 1,07,520 | 1,15,200 | 1,19,040 |
| Fixed cost | 14,400 | 14,400 | 14,400 | 14,400 |
| Total cost | 1,10,400 | 1,21,920 | 1,29,600 | 1,33,440 |
| Profit (sales − total cost) | 9,600 | 12,480 | 14,400 | 15,360 |
| Collection period (days) | 30 | 45 | 60 | 75 |
| Investment in debtors (total cost × days ÷ 360) | 9,200 | 15,240 | 21,600 | 27,800 |
| Required return @ 20% | 1,840 | 3,048 | 4,320 | 5,560 |
| Net benefit (profit − required return) | 7,760 | 9,432 | 10,080 | 9,800 |
Advice. Policy II (60 days) gives the highest net benefit, ₹10,080, against ₹7,760 now. Going on to Policy III adds ₹960 of profit but ₹1,240 of required return on the extra investment, so it is not worth it.
Where the 7 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Costs and profit under each policy | 2.5 |
| 2 | Investment in debtors and required return | 3 |
| 3 | Net benefit and advice | 1.5 |
| Total | 7 |
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