Chuck’s Beer Distributing is considering changing its credit policy from “net 45

Question

Chuck’s Beer Distributing is considering changing its credit policy from “net 45” to “2/20, net 45”. The firm expects its average collection period to decrease by 12 days, and 40% of its customers to take the cash discount. Chuck’s current credit sales of $40 million are not expected to change if the firm offers the cash discount. The firm’s bad-debt loss ratio is expected to remain at 4% if it adopts the credit terms. Chuck’s variable cost ratio is 70%, and it is able to invest at a rate of 16%. The firm does not expect its inventory level to change as a result of its proposed change in credit terms.

Compute the funds released by the change in credit terms.

Compute the net impact the change in credit terms has on Chuck’s pre-tax profits.

Explanation / Answer

Earlier fund used to released in 45 dyas ie => 38.4 million as 4% is badd debta

as funds releases by change in credit terms => (40million * 40% ) - 2%discount

=> 15.68 million within first 20 days. and remaining is $ 22.4 million

total collections => 15.68 + 22.4 => $ 38.08 million

Though collections in credit policy reduced by 0.32 million but also reduced average collection period and also firm able to get funds back earlier so cycle of business, flow of money can go on in proper manner, ie less block of working capital.

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