Financial management revision question and answer

Mwomboko Company Ltd currently operates with terms of net 30 days. The company has sales of Sh.12 million and its average collection period is 45 days. To stimulate demand, the company is considering the possibility of offering terms of net 60 days. If it offers these terms sales will increase 20%. After the change the average collection period is expected to increase to 75 days with no difference in payments habits between old and new customers.

The company has variable costs of Sh.70 for every Sh.100 of sales. The required rate of return on receivables is 20%.

Required:
Should the company extend its credit period? (Assume a year has 360 days

ANSWER

Net contribution = 30% (20%) Sh.12,000,000 = Sh.720,000

Additional cost

Cost of Financing Receivable

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