The "Hulchul hardware Company" expects to have sales of Tk. 20 million this year under current operating policies. Its variable costs as a proportion of sales are 0.80, and its cost of receivables financing is 8 percent. Currently the firm's credit term is net 25. However its average collection period (DSO) is 30 days, indicating that some customers are paying late, and its bad debt losses are 3 percent of sales.
The company's Managing Director Mr. Tejabhai has asked his credit Manager Mr. Radhesham to evaluate the following alternative credit policy and propose whether this policy should be adopted.
Under the proposed policy, the credit period will be lengthened to 40 days, which, it is expected, will raise sales to Tk.20.50 million. Furthermore, the company's days sales outstanding will increase 45 days and bad debt losses on the incremental sales would be 5 percent. Existing customer bad debt losses would remain a 3 percent.
Mr. Radhesham decides to use the income statement approach for analysing the proposed changes in the credit policy.
If you were Radhesham, what decision would you have recommended to Tejabhai? Justify your reasons with necessary calculations.