Question 1

Stellar plc reviews its credit policy at regular intervals. Its current policy offers customers a 60 days credit period with a discount of 2% for all payments settled within 30 days. 30% of its customers pay on average in 70 days. Bad debts currently stand at 4% of annual sales. Sales forecast for next year is EUR 1,250,000, assuming this credit policy is maintained.

Two new policy proposals have been put forward by the senior management team. They are as follows:

Proposal 1

The finance director has called for the policy to be tightened. He believes customers should be offered a discount of 2% on pay settlement within 10 days, and the remaining customers not taking advantage of the discount should be offered a credit period of 30 days. It is expected that only 15% of customers would take advantage of the discounting facility, and the remaining customers would pay on average in 45 days. Bad debt will fall to 2% and annual sales forecast is not expected to change under this policy. To tighten the policy, the company would incur costs of EUR30,000

Proposal 2

The marketing director takes an opposing view and she suggests that the policy should be relaxed to attract more customers. She proposes that customers be offered a 3% discount for all payments settled within 30 days. It is expected that 40% of customers would take advantage of the discounting facility. Policy for the remaining customers will be lax and they are likely to pay on average in 90 days. This proposal is likely to be attractive to the market and the marketing team forecasts sales will rise by 25% if this policy is introduced. They accept it may attract high-risk customers and propose that provision for bad debt be set to 6% of annual sales.

Stellar plc earns a contribution of 25% on sales revenue and its cost of capital has been estimated at 10% per annum.

Assume that 1 year comprises 365 days.

ANSWER THIS:

Advise Stellar plc, about which of the two proposals, if any, to adopt