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M/s ABC's present credit terms are 1/10 net 30 that they are planning to change to 2/10 net 30. The current average collection period is 20 days and the variable cost to sales ratio is 85 and the cost of capital is 10%. The proportion of sales on that customers now take discount is .5. After relaxation of discount terms this is assumed that the ACP will decrease to 14 days, sales will rise from Rs.80 lakhs to Rs 85 lakhs and the proportion of discount sales will rise to .8. Tax rate for the firm is 40% compute the effect of above modifications on net profit.
Solution:
? I = (ACPn - ACP0) [S0/360] + V(ACPn)( ?S/360)
? I = 80/360 (20 - 14) - .85 × 5/360 × 14
= 1.1680555 lakhs
? DIS = Pn (S0+ ? S) dn - P0S0d0
= .96 lakhs
? NP = ? S (1 - v) - ? DIS] (1 - t) + k ?I
= [5 (1 - .85) - .96] (1 - .4) + .1 ×1.1680555
= (.75 - .96) (.6) + .116805555
= - .126 + .11680555
= - .009194 lakhs
As the increase in net profit is negative the cash discount policy must not be liberalized.
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