QUESTION $1$

$[20$ marks$]$

Blue Valley Incorporated is considering shortening its credit period from $30$ days to

$20$ days and believes, as a result of this change, its average collection period will

decrease from $36$ days to $30$ days. Bad debt expenses are also expected to decrease

from $1\mathrm{.}2$ percent to $0\mathrm{.}8$ percent of sales. The firm is currently selling $300,000$ units but

believes as a result of the change, sales will decline to $275,000$ units. On $300,000$

units, sales revenue is $R4,200,000,$ variable costs total $R3,300,000,$ and fixed costs

are $R300,000.$

The firm's required rate of return on equal$-$risk investments is similar to the rate at

which the firm sources for financing. Two alternative financing sources are usually

available:

Tiger Bank Limited usually offers the firm a R$500000$ annual loan at $13\%$ discount

interest, with a compensating balance of $10\%,$ while Lion Bank limited usually offers

the same annual amount at $14\%$ simple interest with interest payable monthly. Blue

Valley Incorporated prefers to take the cheaper option and the firm assumes a $360.$

day per year cycle.

REQUIRED

$1\mathrm{.}1$ Determine the firm's acceptable rate of return on equal$-$risk investments.

$1\mathrm{.}2$ Calculate the reduction in the profit contribution resulting from the decline in

sales.

Jetermine the cost of marginal investment in accou

his change.

Caloulate the pora

ad debts resulting from this change

Would you recommend this change