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Question 4 Chill plc, a manufacturer of leisure equipment, is proposing to loosen the company's existing credit policy under which it allows customers a maximum credit period of 30 days, with a 3% discount for payment within 10 days. In practice only 18% of the customers pay within the discount period of 10 days. 46% of the customers prefer to pay within the maximum credit period of 30 days. The remaining 36% of customers are late payers - on average, these late payers take 40 days to pay their bills. The following changes to the company's credit policy are now proposed: Offer a 6% discount to customers who pay within 20 days. The other customers would be required to pay within 60 days. The Marketing Manager believes that the more generous credit terms would attract new customers and, according to her estimates, the company's turnover would be likely to increase by 100 million - i.e. from the current level of 300 million to 400 million. Chill plc currently suffers bad debt losses of 2% of the net turnover. The more relaxed credit policy is expected to increase the bad debt percentage to about 3.1% of net turnover. 30% of customers are expected to take the discount by paying in 20 days. Another 40% are expected to decline the discount but pay within the new maximum credit period of 60 days. The remaining 30% are expected to delay payment by a further 20 days (beyond the new maximum credit period allowed). Chill ple's variable cost ratio is 86%, the interest rate on working capital finance is 12%, and the company's tax rate is 19%. Required: a) Evaluate the impact of the revised credit policy on Chill's average collection period and net profit. (Figures in millions should be rounded to two decimal places). Recommend whether the company should change its credit policy on the lines suggested. (15 marks) b) With the help of a suitable diagram, explain the difference between conservative and aggressive working capital investment policies, and the impact of such policies on risk and return. (8 marks) Does the proposed change of credit terms by Chill plc represent a move to a more conservative or a more aggressive working capital policy (2 marks) c) (Total 25 marks) Question 4 Chill plc, a manufacturer of leisure equipment, is proposing to loosen the company's existing credit policy under which it allows customers a maximum credit period of 30 days, with a 3% discount for payment within 10 days. In practice only 18% of the customers pay within the discount period of 10 days. 46% of the customers prefer to pay within the maximum credit period of 30 days. The remaining 36% of customers are late payers - on average, these late payers take 40 days to pay their bills. The following changes to the company's credit policy are now proposed: Offer a 6% discount to customers who pay within 20 days. The other customers would be required to pay within 60 days. The Marketing Manager believes that the more generous credit terms would attract new customers and, according to her estimates, the company's turnover would be likely to increase by 100 million - i.e. from the current level of 300 million to 400 million. Chill plc currently suffers bad debt losses of 2% of the net turnover. The more relaxed credit policy is expected to increase the bad debt percentage to about 3.1% of net turnover. 30% of customers are expected to take the discount by paying in 20 days. Another 40% are expected to decline the discount but pay within the new maximum credit period of 60 days. The remaining 30% are expected to delay payment by a further 20 days (beyond the new maximum credit period allowed). Chill ple's variable cost ratio is 86%, the interest rate on working capital finance is 12%, and the company's tax rate is 19%. Required: a) Evaluate the impact of the revised credit policy on Chill's average collection period and net profit. (Figures in millions should be rounded to two decimal places). Recommend whether the company should change its credit policy on the lines suggested. (15 marks) b) With the help of a suitable diagram, explain the difference between conservative and aggressive working capital investment policies, and the impact of such policies on risk and return. (8 marks) Does the proposed change of credit terms by Chill plc represent a move to a more conservative or a more aggressive working capital policy (2 marks) c) (Total 25 marks)