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

Kaveri Foods has annual credit sales of ₹60,00,000 with a 30-day average collection period. Variable cost is 70% of sales and bad debts are 1% of sales. It plans to extend credit to 60 days, which would raise sales to ₹75,00,000 and bad debts to 2% of sales. The cost of funds is 15% p.a. and the year has 360 days. Investment in receivables is measured at variable cost. What is the net incremental benefit of the proposal?

The net incremental benefit is ₹2,81,250. Extra contribution of ₹4,50,000 less extra bad debts of ₹90,000 and the carrying cost of ₹78,750 on the additional ₹5,25,000 invested in receivables, measured at variable cost, leaves ₹2,81,250.

  1. A₹2,81,250Correct
  2. B₹3,60,000
  3. C₹2,47,500
  4. D₹3,41,250

Explanation

Incremental contribution = 15,00,000 × 30% = ₹4,50,000. Incremental bad debts = 1,50,000 − 60,000 = ₹90,000. Receivables at variable cost: existing 60L × 70% × 30/360 = ₹3,50,000; proposed 75L × 70% × 60/360 = ₹8,75,000; the increase is ₹5,25,000, and the carrying cost at 15% is ₹78,750. Net benefit = 4,50,000 − 90,000 − 78,750 = ₹2,81,250. The ₹3,60,000 figure ignores the carrying cost. ₹2,47,500 values receivables at sales instead of cost. ₹3,41,250 charges bad debts only on the extra sales.

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