Question

1. Your firm is considering a new credit policy. While its current policy is cash only, the new policy would involve extending credit for one period. Based on the following information determine if a switch is advisable if the interest rate is 2.0 percent per period.

Current Policy           New Policy

            Price per Unit                                                  Tshs    1,750               Tshs    1,750

            Cost per Unit                                                   Tshs    1,300               Tshs    1,300

            Sales per Period (Units)                                              10,000                         11,000

Answer 1

Profit under new policy:

Sales per period = Sales in units*Price per unit = 11,000*1,750 = 19,250,000

Cost per period = Sales in units*Cost per unit = 11,000*1,300 = 14,300,000

Interest cost = Sales per period*interest rate = 19,250,000*2% = 385,000

Profit = Sales per period - Cost per period - Interest cost = 19,250,000 - 14,300,000 - 385,000 = 4,565,000

Profit under current policy:

Sales per period = Sales in units*Price per unit = 10,000*1,750 = 17,500,000

Cost per period = Sales in units*Cost per unit = 10,000*1,300 = 13,000,000

Profit = Sales per period - Cost per period = 17,500,000 - 13,000,000 = 4,500,000

Incremental benefit over current policy = Profit under new policy - Profit under current policy = 4,565,000 - 4,500,000 = 65,000