
2. Suppose, a firm is contemplating an increase in the credit period from 30 to 60 days, the average collection period which is at present 45 days is expected to increase to 75 days.  It is also likely that the uncollectible expenses will increase from the current level of 1 percent to 3 percent of sales.  Total credit sales are expected to increase from the level of 30,000 units to 34,500 units.  The present average cost per unit is $8, the variable cost and sales per unit are $ 6 and $10 per unit respectively.  Assume the firm expects a rate of return of 15 percent.   Should the firm extend the credit period?

To evaluate whether the firm should extend the credit period, we will need to analyze the costs and benefits of this decision, similar to the previous analysis. The goal is to determine whether the increase in sales and profits will compensate for the higher uncollectible expenses and the longer collection period.

### Step 1: Current Situation Analysis

1. **Sales Revenue**:
   - Current sales volume: 30,000 units
   - Selling price per unit: $10
   - Total sales revenue = $ 30,000 \times 10 = \$300,000 $

2. **Variable Costs**:
   - Variable cost per unit: $6
   - Total variable costs = $ 30,000 \times 6 = \$180,000 $

3. **Contribution Margin**:
   - Contribution margin per unit = Selling price per unit - Variable cost per unit = $ 10 - 6 = \$4 $
   - Total contribution margin = $ 30,000 \times 4 = \$120,000 $

4. **Uncollectible Accounts**:
   - Current uncollectible percentage: 1%
   - Total uncollectible accounts = $ 1\% \times 300,000 = \$3,000 $

5. **Average Collection Period**:
   - Current average collection period = 45 days

### Step 2: Proposed Credit Extension Analysis

1. **Sales Revenue**:
   - New sales volume = 34,500 units
   - Selling price per unit = $10
   - Total sales revenue = $ 34,500 \times 10 = \$345,000 $

2. **Variable Costs**:
   - Variable cost per unit = $6
   - Total variable costs = $ 34,500 \times 6 = \$207,000 $

3. **Contribution Margin**:
   - Contribution margin per unit = $ 10 - 6 = 4 $
   - Total contribution margin = $ 34,500 \times 4 = \$138,000 $

4. **Uncollectible Accounts**:
   - New uncollectible percentage: 3%
   - Total uncollectible accounts = $ 3\% \times 345,000 = \$10,350 $

5. **Average Collection Period**:
   - New average collection period = 75 days

### Step 3: Evaluate the Costs and Benefits

1. **Difference in Contribution Margin**:
   - Current contribution margin = $120,000
   - New contribution margin = $138,000
   - Difference = $ 138,000 - 120,000 = +\$18,000 $

2. **Difference in Uncollectible Accounts**:
   - Current uncollectible accounts = $3,000
   - New uncollectible accounts = $10,350
   - Difference = $ 10,350 - 3,000 = +\$7,350 $

3. **Impact on Accounts Receivable**:
   - Average collection period increases from 45 days to 75 days. This means more capital is tied up in receivables, which reduces the amount available for reinvestment at a rate of return of 15%.
   - Current average accounts receivable = $ \frac{45}{365} \times 300,000 = \$36,986.30 $
   - New average accounts receivable = $ \frac{75}{365} \times 345,000 = \$70,890.41 $
   - Increase in average accounts receivable = $ 70,890.41 - 36,986.30 = \$33,904.11 $
   - Cost of additional investment in accounts receivable = $ 15\% \times 33,904.11 = \$5,085.62 $

### Step 4: Net Impact on Profitability

- Increase in contribution margin: +$18,000
- Increase in uncollectible accounts: -$7,350
- Cost of additional investment in accounts receivable: -$5,085.62

Net impact on profitability:
\[ 18,000 - 7,350 - 5,085.62 = +\$5,564.38 \]

### Conclusion:
The net impact on profitability is positive, with an increase of $5,564.38. Therefore, the firm should extend the credit period, as it improves overall profitability despite the increased uncollectible accounts and higher accounts receivable.

Would you like further details on any part of this analysis or have any other questions?

Here are some related questions:
1. How does extending the credit period affect customer relationships and future sales?
2. What are some alternative ways to increase sales without extending the credit period?
3. How can the firm mitigate the risk of uncollectible accounts when offering longer credit periods?
4. What is the impact of a higher rate of return on investment on this decision?
5. How can a firm optimize its credit policy for different customer segments?

**Tip:** Extending credit can drive sales growth, but it's important to monitor the balance between sales gains and potential bad debts.

Explore the analysis of extending the credit period from 30 to 60 days and its impact on sales, profitability, and financial management decisions. Includes detailed calculations on contribution margin, accounts receivable turnover, and cost-benefit analysis. Ideal for financial analysts and managers.

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