Marginal Profitability from Relaxing Credit Policy


 
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Marginal Profitability from Relaxing Credit Policy
Phani Kumar
Suppose the annual sales of XYZ Ltd. is Rs. 24,000,000. After 6 months an account is turned over to a collection agency and on average one percent of the total receivable volume under the
present credit policy is never received by the firm. The current policy and the expected effects of two proposed policies, A and B, are compared in following table:
Present Policy / Policy A / Policy B
Additional demand (Percentage) 0 / 25 / 35
Average collection period 1 month / 2 months / 3 months
Default losses (Percentage) 1 / 3 / 6
Determine the marginal profitability from relaxing the credit policy:
- from the present policy to policy A and then from policy A to policy B
- by comparing the marginal profitability to the required rate of return (20%) on additional
investment in receivables.
 

   

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