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Multitech Credit Policy Analysis Report

Multitech Ltd is considering relaxing its credit policies to increase sales. It currently offers 30 days of credit to approved customers and a 1/10 net 30 cash discount. Extending credit to riskier customer categories could increase sales by Rs. 50 million but with 12% expected bad debt. Increasing the credit period to 60 days could boost sales by Rs. 40 million but reduce cash discount participation and increase the average collection period. Offering a more generous 2/10 net 30 discount may raise sales by Rs. 20 million while improving cash discount participation and shortening the average collection period. You have been asked to analyze the effect of each option on residual income.

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9 views1 page

Multitech Credit Policy Analysis Report

Multitech Ltd is considering relaxing its credit policies to increase sales. It currently offers 30 days of credit to approved customers and a 1/10 net 30 cash discount. Extending credit to riskier customer categories could increase sales by Rs. 50 million but with 12% expected bad debt. Increasing the credit period to 60 days could boost sales by Rs. 40 million but reduce cash discount participation and increase the average collection period. Offering a more generous 2/10 net 30 discount may raise sales by Rs. 20 million while improving cash discount participation and shortening the average collection period. You have been asked to analyze the effect of each option on residual income.

Uploaded by

burnsop7
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Multitech Ltd.

Multitech Limited, set up by a few technocrats in the mid 1990s enjoyed a fairly healthy growth
rate till two years ago. Intense competition in the last few years has slowed down the growth
rate considerably.
The present sales of Multitech is Rs.800 million. In a recent executive committee meeting,
Jeevan Reddy, the marketing director, argued for relaxing the credit policy of Multitech to
stimulate sales increase. Gautam Sanghvi, the finance director, promised to consider this
request favourably, provided the relaxation in credit policy had a positive impact on residual
income.
The present credit policies of Multitech are as follows:

Credit Standards Multitech classifies its customers into 4 categories, 1 through 4. Credit rating
diminishes as one goes from category 1 to category 4. Customers in category 1 have the highest
credit rating whereas customers in category 4 have the lowest credit rating. Currently Multitech
extends unlimited credit to customers in categories 1 and 2, limited credit to customers in
category 3, and no credit to customers in category 4.

Credit Period Multitech provides, 30 days of credit to its customers who are deemed eligible
for credit under its credit standards.

Cash Discount: To induce its customers to pay early, Multitech offers cash discount. Its credit
terms are 1/10 net 30.

You have recently joined Multitech as a financial analyst and Gautam Singhvi has asked you
to examine the effect of relaxing credit standards, extending the credit period, and providing
more generous cash discount.
After talking to executives in the marketing, production, and finance departments you have
gathered the following information.
• Presently the proportion of credit sales and cash sales are 0.7 and 0.3. 50 percent of
the customers (by value) who are granted credit avail of cash discount.
• The contribution margin ratio for Multitech is 20 percent, the tax rate for Multitech
is 30 percent, the post-tax cost of capital for Multitech is 12 percent, and the average
collection period (ACP) on credit sales is 20 days.
• If the company extends unlimited credit to customers in category 3 and limited
credit to customers in category 4, the sales of the company would increase by Rs.50
million on which the bad debt losses would be 12 percent. The ACP, however, will
remain unchanged at 20 days.
• If the company extends its credit period from 30 days to 60 days, its sales to
customers who are granted credit will increase by Rs.40 million. Further, the
percentage of customers who will avail of cash discount will decrease to 20 percent.
The ACP, as a result of the extension of the credit period, will increase to 50 days.
• If the company relaxes its discount terms to 2/10 net 30, its sales to customers who
are granted credit will increase by Rs.20 million. Further, the percentage of credit
customers who will avail of cash discount will increase to 70 percent and the ACP
will decrease to 16 days.
a. What will be the effect of relaxing the credit standards on residual income?
b. What will be the effect of extending the credit period on residual income?
c. What will be the effect of relaxing the cash discount policy on residual income?
Examine the impact of these credit policy changes one at a time.

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