Question 1 [24 marks]

Your uncle Paul owns a takeaway shop on the corner of Church Street.

Your uncle has made special arrangements with some of his customers to purchase pies throughout the month where he collects the money after 30 days.

Uncle Paul reckons that if he informs his customers that he will give them a collection period of 45 days instead of the current 30, his credit sales will increase from 13 000 pies in the previous financial year to 24 000 pies.

Your uncle knows that if he implements a more lenient policy, it will increase his bad debts from 1% of credit sales to 2.5% of credit sales.

Uncle Paul does not currently give discount, but he estimates that 40% of his total customers will make use of this if he implements a discount policy of 5% discount if his customers pay within 10 days.

The selling price of a pie is R14.50 and the variable cost per pie is R6.

Use 360 days per year and 30 days per month.

Your uncle Paul has a required return on investment of 12%

1.1 Calculate the effect on profit

1.2 Calculate the cost of marginal investment in accounts receivable

1.3 Calculate the effect on bad debt

1.4 Calculate the cost of settlement discount

(4 Marks) (11 Marks) (4 Marks)

(3 Marks)

1.5 If your uncle had a net increase in profit under the proposed credit terms, make a recommendation if he should implement the new credit terms or not the option you are recommending.