A.

Your first major assignment as a financial analyst after your promotion at Ice Nine is overseeing the
management of accounts receivable and inventory. The first item that you must attend to involves the
proposed change in credit policy that would involve relaxing credit terms from the existing 1/50, net 70 to
2/60, net 90 in hopes of securing new sales. The management at Ice Nine does not expect bad debt losses
on their current customers to change under the new credit policy. The following information should aid your
analysis:

New Level of Sales (all credit) P8 million

Original sales level (all on credit) P7 million
Contribution margin 25%
Percent of bad debt losses on new sales 8%
New average collection period 75 days
Original average collection period 60 days
Additional investment in inventory P50,000
Pre-tax required rate of return 15%
Percentage of customers taking the new cash discount 50%
Percentage of customers taking the old cash discount 50%

To help you in your decision on relaxing credit terms, you have been asked to respond to the following
questions:

1. If a firm currently buys from Ice Nine on credit with the present terms of 1/15, net 70 and decides to
forego the trade credit discount and pay on the net day, what is the effective annualized cost to that firm
of forgoing the discount?
2. If Ice Nine changes its trade credit terms to 2/60, net 90, what is the effective annualized cost to a firm
that buys from Ice Nine and decides to forego the trade discount and pay on the net day.
3. What is the estimated change in profits resulting from the increased slaes less any additional bad debts
associated with the proposed change in credit policy?
4. Estimate the cost of additional investment in accounts receivable and inventory associated with this
change in credit policy.
5. Estimate the cost of the cash discount if the proposed change in credit policy is enacted?
6. Estimate the incremental revenues with incremental costs. Should the proposed change be enacted?

B. Foxbase Inc. is considering a major change in credit policy. Managers are considering tightening its credit
policy due to its tight cash position and liquidity issues. Managers are considering shortening its credit term
from 2/60, net 90 to 1/50, net 70 days. Under the old policy, Sales (all on credit) amounted to P9 million.
The average age of receivables was 75 days and bad debts experience was 8% while the percentage of
customers taking advantage of the discount was 50%. However, with the proposed change, sales will
decrease by P1 million but the average collection period will accelerate to 60 days. With the higher
percentage of discount, the percentage of customers taking advantage will be 55% and bad debt
experience will be 7%. The company’s contribution margin ratio will remain at 25% but a P50,000 reduction
in the amount of inventory to be maintained will be realized. Foxbase pre-tax required rate of return is 15%.

Required:
1. What is the benefit (savings) from the adoption of the new credit policy?
2. What is the cost (opportunity) from the adoption of the new credit policy
3. What is the net advantage or disadvantage of adopting the system? Would recommend for its
adoption?

C. Imogen Heap, Inc.’s Chief Financial Officer is in the process of conducting an evaluation of the company’s
working capital policies, particularly its accounts receivable. The financial records of the company show
that last year, sales totaled P240 million, of which 75% are on credit. The company’s term for credit sales I
3/13, n/90 and its variable cost ratio is 75%.

It was estimated that about 60% of the company’s customers take advantage of the discount and the rest
pass up on the discount offered. Based on this set up, the average collection period for Imogen is
computed to be about 50 days. Additional reports provided by the credit department indicate that about
0.5% of the credit sales end as bad debts.

The company’s CFO is determined to shorten the company’s average collection and improve the company’
over all profitability. He is studying two alternatives suggested by the company’s external analyst:

1. Increase cash discount rate to 4% with all other elements of the credit term constant. Such move
would increase the number of customers who will take advantage of the discount to 65% and ACP
would be shortened to 30 days. A P10,000 collection costs will also be saved.
 2. Implement a stricter credit term of 2/10, net 60. With these, the number of customer taking the
discount will remain and ACP would be shortened to 33 days. However, credit sales are expected
to decrease by 5% from its present level.
The company’s minimum hurdle rate for all its investment is established at 12% and uses a
360-day business year.

Required: Undertake a cost-benefit analysis for both alternatives and make your recommendations to the
company’s CFO.

D. The Hyndford Street Corporation is considering relaxing its current credit policy. Currently the firm has
annual sales (all on credit) of P6 million and an average collection period of forty days(assume a 360-day
year). Under the proposed change the trade credit terms would be changed from net 40 days to net 90
days and credit would be extended to a riskier class of customer. It is assumed that bad debt losses on
current customers will remain at their current level. Under this change, it is expected that sales will increase
to P7million. In addition, the following information were presented:

Contribution Margin 30%

Percent bad debt losses on new sales 8%
Additional investment in inventory P540,000
Pre-tax required rate of return 15%

Required: Given the following information, should the firm adopt the new policy?