Arvind Juicer and Mixer sells 80% of its product on credit terms after due scrutiny of the customers’ financial soundness and their past history of payment. This means that cash sales are limited in...

Arvind Juicer and Mixer sells 80% of its product on credit terms after due scrutiny of the customers’ financial soundness and their past history of payment. This means that cash sales are limited in view of the risky customers. The term of credit is net 30; however, to boost up the sales, the company provides 2% discount if payment is made within the first 10 days. It may be mentioned that 80% of the credit-availing customers are availing cash discount.

The sales amount is Rs 2 million. The contribution margin ratio is 25%. Tax rate is 30%. Post-tax cost of capital is 12%. The average collection period is 11 days in case of 2/10 net 30 and 16 days in case of net 30 terms. If the company liberalises the credit policy to net 60, sales are expected to rise to Rs 2.2 million. But the collection cost rises from 2% to 3% and bad debt losses are expected to move up from 1.5% to 3%. The administrative cost is not expected to change. In this context, the finance manager has to find out whether there should be change in the credit standard from net 30 to net 60.

1. Prepare a pro forma income statement on the basis of the present variables and the expected changes.

2. Find whether the new credit standard of net 60 should be followed.