The management team at MJR Ltd. (MJR) is considering changing the credit policy MJR offers to its customers from 2/10 net 90 to 3/10 net 45 to be more competitive. Bad debts are currently 1% of quarterly sales of $12.5 million. Variable costs are 40% of sales, of which 4% is selling and administrative costs and the balance is cost of goods sold. The average collection period is 50 days, with 55% of MJRs customers taking the discount. Inventory turnover is 6.25, which is consistent with the industry standard.

MJRs management team estimates that if MJR changes its credit policy the following will occur:

• Sales will increase by 5%.
• Bad debts will increase to 2% of sales.
• 65% of customers will take the new discount and will pay within 10 days, 32% will pay within 45 days, and 3% will pay within 90 days.
• There will be NO change in the inventory turnover rate.

MJR applies a discount rate of 9.5% for analyzing working capital decisions.

Required:

a) Determine the total estimated incremental benefit or cost from implementing this new credit policy and recommend whether MJR should change its policy.

(11 marks)

b) Explain the difference between the conservative and aggressive approaches to financing working capital. Describe one disadvantage for each approach. (3 marks