Hunter pic requires advice on its debt collection policy of doctor are consideri

Question

Hunter pic requires advice on its debt collection policy of doctor are considering two options for reducing bad debts and shortening the period of credit extended to Us debtors The current situation is as tonnes Option 1 involves offering a 2% discount for prompt payment. It is expected that this will not affect the level of sales but that half of the sales each year would be made at a 2% discount adding an extra 48.000 to the current annual expenditure on debt collection procedures. The positive effects of this option would be to reduce bad debts by 0 5% and reduce the average collection period by 30 days Option 2 Is to expand the credit control department to enable it to chase debts more effectively. This would Increase annual costs by 100.000. reduce bad doubts by 1% and reduce average collection period by 60 days. Should the current policy be discarded in favour of option 1 or option 2? Johnson Ltd requires advice on its debt collection policy. Its directors are considering two options for reducing bad debts and shortening the period of credit extended to its debtors Option 1 involves employing an additional credit controller and option 2 involves employing 2 extra staff and allocating additional office space. The costs and likely effect of each of these options is set out below and compared to the current position. Current sales are euro 4,800, 000 a year, and the company requires a 20% return on its investments. Should the current policy be discarded in favour of option 1 or option 2?

Explanation / Answer

Dear student, only one question is allowed at a time.

a)

Option 1

Collection cost = $180,000

Discount = $4,800,000 x 50% x 2% = $48,000

Bad Debt = $4,800,000 x (2-0.5)% = $72,000

Interest loss on collection = $4,800,000 x 90 / 360 x 10% (assuming 360 days) = $120,000

So, Total Cost = $420,000

Option 2

Collection cost = $280,000

Bad Debt = $4,800,000 x (2-1)% = $48,000

Interest loss on collection = $4,800,000 x 60 / 360 x 10% (assuming 360 days) = $80,000

So, Total Cost = $408,000

So, Option 2 is better.

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