Delta Metal House (DMH) is considering changing its credit terms from net 40 to net 50, in order to increase sales. Past average collection period is 60 days and it will be 75 days under proposed…

Analysis of Credit Terms Change for Birat Trading Company (BTC)

1. Calculate Additional Sales Revenue and Variable Costs

• Current sales: Rs 6,000,000
• Proposed sales: Rs 7,200,000
• Increase in sales: Rs 1,200,000
• Variable cost ratio: 70%
• Additional variable costs: $1,200,000\times 0.70=\text{Rs }840,000$

2. Calculate Additional Bad Debt Expense

• Current bad debt ratio: 2%
• Proposed bad debt ratio: 2.5%
• Increase in bad debt ratio: 0.5%
• Additional bad debt: $1,200,000\times 0.005=\text{Rs }6,000$
• However, bad debt applies to total sales (Rs 7,200,000 at 2.5%): $7,200,000\times 0.025=\text{Rs }180,000$ Current bad debt: $6,000,000\times 0.02=\text{Rs }120,000$ Increase in bad debt: $180,000-120,000=\text{Rs }60,000$ (Correction: Bad debt is calculated on total sales, not just the increase.)

3. Calculate Additional Profit Before Tax (PBT)

• Additional PBT: $1,200,000-840,000-60,000=\text{Rs }300,000$

4. Calculate Tax on Additional Profit (30%)

• Tax: $300,000\times 0.30=\text{Rs }90,000$

5. Calculate Net Incremental Profit After Tax

• Net profit: $300,000-90,000=\text{Rs }210,000$

6. Calculate Additional Investment in Receivables

• Current average collection period (ACP): 45 days
• Proposed ACP: 60 days
• Increase in ACP: 15 days
• Average daily sales: $6,000,000/365\approx \text{Rs }16,438$
• Proposed average daily sales: $7,200,000/365\approx \text{Rs }19,726$
• Average receivables (current): $16,438\times 45=\text{Rs }740,000$
• Average receivables (proposed): $19,726\times 60=\text{Rs }1,183,560$
• Increase in receivables: $1,183,560-740,000=\text{Rs }443,560$ (Correction: Use average sales for calculation.)

Simplified Approach (Using Average Sales):

• Average sales: $(6,000,000+7,200,000)/2=\text{Rs }6,600,000$
• Average daily sales: $6,600,000/365\approx \text{Rs }18,082$
• Increase in receivables: $18,082\times 15=\text{Rs }271,230$

7. Calculate Opportunity Cost of Funds (10%)

• Opportunity cost: $271,230\times 0.10=\text{Rs }27,123$

8. Net Present Value (NPV) of the Change

• Incremental cash inflow (after tax): Rs 210,000
• Incremental cash outflow (opportunity cost + bad debt): $27,123+60,000=\text{Rs }87,123$
• Net cash flow: $210,000-87,123=\text{Rs }122,877$

Final Decision: Since the incremental net benefit (Rs 122,877) is positive, BTC should change its credit terms from 'net 40' to 'net 50' to increase sales despite higher bad debts and receivables. The increase in profitability outweighs the additional costs.

(Note: For precision, use exact calculations with daily sales and proper bad debt adjustments.)