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WORKING CAPITAL QUESTIONS

1. Change in Credit Standards


A company deals with four categories of clients. Potential sales to each category,
starting from low to high risk is Rs.1.2 crore, Rs. 1.0 crore, Rs. 0.55 crore and
Rs.0.40 crore. Average collection period is 30 days, 35 days, 45 days and 60 days.
Bad debt ratio is negligible in case of first two categories while it is 2 per cent and
5 per cent respectively in 3rd and 4th category. Currently, the company extends
unlimited credit to the first three categories of customers and none to the last
category. The companys variable cost ratio is 80 per cent, after tax required rate of
return 15%, corporate tax rate 35%. The company wants to extend full credit to
category four customers. It is expected that 5% collection costs will have to be
spent for this category of customers. Should the firm relax its credit standards?

2. Credit Granting decision


Suppose a customer wants to purchase goods of Rs.20,000 on 4 month credit.
There is 90% probability that customer will pay in four months and 10%
probability that he will not pay anything. The cost of goods sold is Rs.14,000.
Firms required rate of return is 18%. Should credit be granted?
3. Repeat Order
A new customer has asked for credit of Rs.11,000 for three months. There is 85%
probability that he will pay and 15% probability he will not pay. The firms
investment is Rs.8,000 and it has required rate of return 15%. If the customer
actually pays and places a repeat order, there is 95% chance he will pay in the
second period. Should credit be granted?
4. Change in Credit Period
A firm is considering to increase its credit period from net 35 to net 50. The firms
sales are expected to increase from Rs.120 lakh to Rs.180 lakhs. Average collection
period would increase from 35 days to 50 days. The bad debt loss ratio and
collection costs ratio are expected to be 5% and 6% respectively. The firms

variable costs ratio is 85%, corporate tax is 35% and after tax required rate of
return is 20%. Is the new credit policy desirable?
5. Collection Period Impact
An analysis of ABCs credit policy reveals it is very loose as a result the firms
collection period is very long and bad losses are building up. The firm is therefore
considering tightening up its credit standards by shortening credit period from 45
days to 30 days. The expected result is sales would reduce from Rs.6,00,000 to
Rs.5,00,000 and bad debt losses ratio from 4% to 2% and collection expenses from
2% to 1% of total sales. The firms variable cost ratio is 80%, tax rate is 40% and
after tax cost of funds is 12%. Should the firm introduce the change?
6. Cash Discount
ABC is considering introducing a cash discount. Credit terms are net 40 and
would like to change them to 1/15 net 40. The current average collection period is
60 days and is expected to decrease to 30 days with the new credit terms. It is
expected 50% of customers will take advantage of changed credit terms. ABCs
annual sales are Rs.60,00,000 and required return is 15%. Are the new terms
beneficial to firm?