The management of Faulu Limited intends to change the company‟s credit policy, from „net 30‟ to „3/10 net 45‟. If this change is effected, annual sales will increase 12% from the current level of Sh.12 million while the proportion of bad debts will increase from 1% to 1.4% of credit sales. A new credit assistant will also have to be employed at a salary of Sh.260,000 per annum. It is expected that 40% of the credit customers will benefit from the cash discount.
The inventory level and the variable costs will however remain constant at 20% and 75% of the annual credit sales respectively. The rate of return on investment is 14% per annum. All sales are on credit.
Assume a 360 days financial year and ignore the effects of taxation.
Advise the management of Faulu Limited on whether or not to adopt the new credit policy.