A company has annual credit sales of $25 million. The company’s credit terms are 30 days from the invoice date but the average settlement period for trade receivables is 60 days. The company is currently reviewing its credit policy.
The credit controller has proposed a change to the company’s credit policy as follows:
(i) Implement stricter credit control procedures at a cost of $30,000 per year.
and
(ii) Offer customers a 2.5% discount if they pay within 30 days.
It is estimated that, as a result of the proposed change to the credit policy, 60% of customers, by sales value, would pay at the end of the 30 day period. The remainder would take, on average, 50 days to pay. It is not anticipated that the change to the credit policy will result in a reduction in sales revenue.
The company finances its trade receivables by a bank overdraft which has an interest rate of 14% per annum. Required:
Calculate the net annual cost if the credit controller’s proposed change to the credit policy is adopted
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