BLC Ltd. has revenue of £500 million and sells all of its goods on credit to a v
ID: 2498256 • Letter: B
Question
BLC Ltd. has revenue of £500 million and sells all of its goods on credit to a variety of different wholesale customers. At the moment the company offers a standard credit period of 30 days. However, 70% of its customers (by revenue) take an average of 70 days to pay, while the other 30% of customers (by revenue) pay within 30 days. The company is considering offering a 2% discount for payment within 30 days and estimates that 80% of customers (by revenue) will take up this offer (including those that already pay within 30 days). The Managing Director has asked the credit controller if the cost of this new policy would be worth offering. The company has a £80 million overdraft facility that it regularly uses to the full limit due to the lateness of payment and the cost of this overdraft facility is 15% per annum. The credit controller also estimates that bad debt level of 2% of revenue would be halved to 1% of revenue as a result of this new policy.
1. Calculate the approximate equivalent annual percentage cost of a discount of 2%, which reduces the time taken by credit customers to pay from 70 days to 30 days
. 2. Calculate the value of trade receivables under the existing scheme and the proposed scheme at the year-end.
3. Evaluate the benefits and costs of the scheme.
4. explain with reasons whether the company should go ahead and offer the discount. You should also consider other factors in this decision. (Hint: You need to work out the cost of the discount compared to the interest on the overdraft saved and bad debt reduction.)
Explanation / Answer
1. The approximate equivalent annual percentage cost
The equivalent days = (70 – 30) = 40 days
= 365/40 = 9.125
= 1 – 0.02 = 0.98
= 1/0.98 = 1.02
= 1.029.125 = 1.198
Approximateequivalentannualpercentagecost = 1.198 – 1 = 0.198 = 19.8%
2. A. thevalue of trade receivables under theexistingscheme
Totalsales = 500,000,000
Lesspaid within 30 days (30%) = (150,000,000)
Grossaccount receivables = 350,000,000
Lessprovisionforbaddebts 2% = 7,000,000
Accounts receivable at yearend = 343,000,000
B. thevalue of trade receivables under theproposedscheme
Totalsales = 500,000,000
Lesspaid within 30 days (80%) = (400,000,000)
Grossaccount receivables = 100,000,000
Provisionforbaddebts (1%) = 1,000,000
Netaccount receivable = 99,000,000
3. Thecostbenefitsanalysis
Thegrosstrade receivables under thecurrentscheme = 343,000,000
Thecost of debtforfinancingthegap (15% of act rec) = 51,450,000
Addtheprovisionforbaddebts = 7,000,000
Totalcost of currentscheme = 58,450,000
Thegrosstrade receivable under theproposedscheme = 99,000,000
Thecost of debtforfinancingthegap (15% of act rec) = 14,450,000
Addthecost of discount (19.8% of 400 million) = 79,200,000
Addprovisionforbaddebts = 1,000,000
Totalcost of theproposedscheme = 94,650,000
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