It is very normal for students of financial management being asked question on the effect of extending credit terms to increase sales.
Append below is a simple illustration for a better understanding of investment in receivables or extension of credit terms:
Company ABC Ltd has a current sales of $2.6 million. It wants to increase its sales by relaxing its credit policy. The current credit term is 45 days and the proposed terms of credit is 60 days. However the company believes that bad debts will increase from 1.5% to 2% of sales and sales should increase by 10%. The variable operating costs are 72% of the sales. The corporate tax rate is 35% and that the company requires an after-tax return of 15% on its investment.
Should Company ABC Ltd extend its credit policy from 45 days to 60 days?
Yes, it is to the advantage of Company ABC Ltd to extend its credit policy as it achieve a higher rate of return of 8.06%
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