considering a proposal for a more liberal extension of credit which will result in increasing the average collection period from one month to two months. This relaxation is expected to increase the sales by 25% from its existing level. You are required to advise the firm regarding adoption of the new credit policy, presuming that the firm's required return on investment is 25%. Incremental Solution: Appraisal of Credit policy Present Credit period (ACP) 1 month Sales (units) 120000 Sales @ 10 (in Rs) 1200000 Total Cost 1080000 Profit 120000 Proposed 2 months 150000 1500000 1290000 210000 300000 210000 90000 Investment in receivables 1080000 / 12 = 90000 1290000 / 6 = 215000 125000 Required return on Incremental Investment (125000@ 25%) = 31250 Actual return on Investment = 90000 (or) (90000 / 125000) x 100 = 72% Since the Incremental return is greater than required return on Incremental investment advised to adopt new credit policy 444 YASHWANTH Ltd. has received an order from Green Ltd. which insists that the Rs.50,000 of machinery ordered be supplied on 60 days credit. The variable costs of production which would be incurred by YASHWANTH Ltd. in meeting the order amount to Rs.40,000. Green's credit worth while ness is in doubt and the following estimates have been made: Probability of Green Ltd. paying in full in 60 days 0.6 Probability of Green Ltd. completely defaulting 0.4 Financial Management & International Finance 261 However, if the order is accepted by YASHWANTH Ltd. and if Green Ltd, does not default, then there is felt to be a probability of about 0.7 that a further eight identical orders will be placed by Green Ltd. in exactly 1 year's time, and further orders in later years may also be forth coming. Experience has shown that once a firm meets the credit terms on an initial order, the probability of default in the next year reduces to 0.1. Any work carried out on Green's Ltd. order would take place in otherwise idle time and would not encroach upon YASHWANTH Ltd, other activities. Should Green Ltd. defaults, the legal and other costs of debt collection would equal any money obtained. YASHWANTH Ltd, finances all trade credit with readily available overdrafts at a cost of 12% p.a. An appropriate discount rate for long term decisions is 15%p.a. Evaluate the proposal if (1) only one order is expected from Green Ltd., and () if further orders are also expected from it (year may be taken consisting of 360 days)