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Chapter 16

2. Change in collection policy. The Abraham company is planning to increase its


level of collection expenditures from the current P250,000 to P400,000 on credit
sales of P24 million. This move expected to accelerate payments and increase
turnover of receivables from 8 to 12 times and cut bad debts from two percent to
one percent of credit sales. The opportunity cost of funds is 12%. The company
uses a 360-day year in financial planning and controlling.

Required: Calculate the following:


1. Receivable turnovers before and after change in the collection policy.
Before: 8x After: 12x
2. Average receivable balance before and after the change in collection policy.
Before: P3.0M After: P2.0M
*P24M/8 *P24M/12
3. Net advantage (disadvantage) of the new collection policy.
Investment Income [(P3.0M P2.0M) x 12%] P120,000
Increase in collection costs (P400,000 P250,000) (P150,000)
Decrease in bad debts (1% x P24M) P240,000
Net advantage of the new collection policy P210,000

3. Change in credit policy. The Manila Company presently gives terms of net 30
days. It has P60 million in sales, and its average collection period is 45 days. To
stimulate demand, the company may give terms of net 60 days. If this policy is
implemented, sales are expected to increase by 15%. After the change, the average
collection period is expected to be at 75 days, with no difference in payment habits
between old and new customers. Variable cost are P0.80 for every P1.00 of sales,
and the companys required rate of return on investment in receivables is 20%. The
company expects to spend an incremental cost collection cost of P200,000 to
undertake this change in credit policy. The prevailing average market rate of
investment is 15% per annum. Customers default in payments are expected to
reach 3% on total sales as compared from a minimal 1.5% based on the present
credit terms.
Required: Should the company extend its credit period? (Answer a 360-day year.)
Before After
Sales P60M P69M (P60Mx115%)
Collection period 45 days 75 days
Receivable Turnover 8x 4.8x
(360 days/ collection period)
A. Receivable Balance P7.5M P14.375M
(Sales/Rec. Turnover)
Bad Debts P900,000 P2.070M
(1.5% x P60M) (P69M x 3%)
Incremental CM (P9M x 80%) P7,200,000
Opportunity cost [(P14,375,000 P7,500,000) x 80% x 20%] (P1,100,000)
Increase in bad debts (P2,070,000 P900,000) (P1,170,000)
Increase in collection costs (P200,000)
Incremental IBIT P4,730,000

The company is advised to extend its credit period and increase its income before
income tax of P4.73 million.

4. Change in credit policy. Silverstone Corporation has a 12% opportunity cost of


funds and currently sells on terms of net 10, EOM. This means that goods shipped
before the end of the month must be paid for by the tenth of the following month.
The firm has sales of P10 million a year, which are 80% on credit and spread evenly
over the year. Currently , the average collection period is 60 days. If Silverstone
offered terms of 2/10 net 30 sixty percent of the customers would take the discount
, and the collection period would be reduced to 40 days.
Required: Should Silverstone change its term from net/10. EOM to 2/10, net 30?

5. Cost of collection efforts. Dream Corporation spends P220,000 per annum on its
collection department . The company has P12million in credit sales. Its average
collection period is 2.5 months, and the percentage of bad debts loss is 4 %. The
company believes that if it were to double its collection personnel, it could bring
down the average collection period to 2 months and bad debt losses to 3 percent.
The added cost if P180,000, bringing total expenditures to P400,000 annually.
Required: Is the increased effort worthwhile if the opportunity cost of funds is 20%?
If it is 10%?