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CA Intermediate · Financial Management and Strategic Management · Management of Receivables

Kapoor Pharma Ltd currently has annual credit sales of ₹1,20,00,000 with a 30-day credit period and bad debts of 1% of sales. It proposes a 60-day credit period, which will raise sales to ₹1,50,00,000 and bad debts to 2% of sales. Variable costs are 70% of sales, fixed costs will not change, the investment in receivables is measured at variable cost, the required return is 15% and a year is 360 days. What is the net incremental profit from the proposal?

The net incremental profit is ₹5,62,500. Extra contribution of ₹9,00,000 is reduced by extra bad debts of ₹1,80,000 and by a financing cost of ₹1,57,500 on the extra receivables investment of ₹10,50,000 measured at variable cost. The result is ₹5,62,500, so the proposal is worthwhile.

  1. A₹5,62,500Correct
  2. B₹4,42,500
  3. C₹4,95,000
  4. D₹6,82,500

Explanation

Incremental contribution = 30,00,000 × 30% = ₹9,00,000. Incremental bad debts = 3,00,000 - 1,20,000 = ₹1,80,000. Receivables investment: proposed 1,05,00,000 × 60/360 = 17,50,000; current 84,00,000 × 30/360 = 7,00,000; the increase is 10,50,000, and 15% of that is ₹1,57,500. Net = 9,00,000 - 1,80,000 - 1,57,500 = ₹5,62,500. Using the total new bad debt of ₹3,00,000 gives 4,42,500, which is wrong.

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