Annual sale of Vineet Company is 32,000 units @ 25 per unit. Its variable cost is 15 per unit and fixed cost 1,60,000 per year. The company is considering to relex it credit policy this will increase its sales by 20% and average collection period will increase from 30 days to 45 days. Bad debts are expected at 3% on increase in sales and collection charges will increase by 20,000. If required rate of return on Investment is 15% after tax and rate of tax is 40% will it be fair to relax the credit policy ?

To determine if it is fair for Vineet Company to relax its credit policy, we need to analyze the financial impact of the changes. We'll calculate the following:

1. **Current Contribution Margin:**
   \[
   \text{Contribution per unit} = \text{Selling Price per unit} - \text{Variable Cost per unit}
   \]
   \[
   = 25 - 15 = 10 \, \text{per unit}
   \]
   \[
   \text{Total Contribution} = \text{Contribution per unit} \times \text{Current Sales Volume}
   \]
   \[
   = 10 \times 32,000 = 320,000
   \]

2. **Current Net Profit:**
   \[
   \text{Net Profit} = \text{Total Contribution} - \text{Fixed Costs}
   \]
   \[
   = 320,000 - 160,000 = 160,000
   \]

3. **New Sales Volume (After Relaxing Credit Policy):**
   \[
   \text{New Sales Volume} = \text{Current Sales Volume} \times (1 + \text{Percentage Increase in Sales})
   \]
   \[
   = 32,000 \times 1.2 = 38,400 \, \text{units}
   \]

4. **New Contribution Margin:**
   \[
   \text{New Total Contribution} = \text{Contribution per unit} \times \text{New Sales Volume}
   \]
   \[
   = 10 \times 38,400 = 384,000
   \]

5. **New Fixed Costs:**
   The fixed costs increase by the collection charges.
   \[
   \text{New Fixed Costs} = 160,000 + 20,000 = 180,000
   \]

6. **Bad Debts:**
   \[
   \text{Bad Debts} = \text{Increase in Sales} \times \text{Bad Debt Percentage}
   \]
   \[
   \text{Increase in Sales} = (38,400 - 32,000) \times 25 = 6,400 \times 25 = 160,000
   \]
   \[
   \text{Bad Debts} = 160,000 \times 0.03 = 4,800
   \]

7. **New Net Profit Before Tax:**
   \[
   \text{New Net Profit Before Tax} = \text{New Total Contribution} - \text{New Fixed Costs} - \text{Bad Debts}
   \]
   \[
   = 384,000 - 180,000 - 4,800 = 199,200
   \]

8. **Net Profit After Tax:**
   \[
   \text{Tax} = 199,200 \times 0.4 = 79,680
   \]
   \[
   \text{Net Profit After Tax} = 199,200 - 79,680 = 119,520
   \]

9. **Incremental Return:**
   \[
   \text{Incremental Profit} = 119,520 - (160,000 \times (1 - 0.4)) = 119,520 - 96,000 = 23,520
   \]

10. **Required Return on Investment (ROI):**
    First, calculate the additional investment in receivables:
    \[
    \text{Additional Investment} = \frac{\text{Increase in Sales} \times \text{Selling Price per unit} \times \text{Average Collection Period Increase}}{365}
    \]
    \[
    = \frac{6,400 \times 25 \times 15}{365} = \frac{2,400,000}{365} \approx 6,575.34
    \]
    \[
    \text{Required Return} = 6,575.34 \times 0.15 = 986.3
    \]

11. **Comparison:**
    \[
    \text{Incremental Profit} - \text{Required Return} = 23,520 - 986.3 = 22,533.7
    \]

Since the incremental profit of 22,533.7 is positive, it suggests that relaxing the credit policy is financially beneficial for the company.

**Conclusion:** Yes, it would be fair to relax the credit policy as the incremental profit exceeds the required return on the additional investment.

Would you like further details or have any questions?

Here are some related questions:
1. How does the average collection period impact a company's liquidity?
2. What are the potential risks associated with relaxing credit policies?
3. How can a company mitigate the risks of bad debts?
4. What other factors should be considered when adjusting credit policies?
5. How can a company calculate the optimum credit period?

**Tip:** Regularly review your credit policy to ensure it aligns with your company's financial goals and market conditions.

Explore how relaxing the credit policy affects Vineet Company's profitability with a detailed financial analysis. Calculate the incremental profit, considering increased sales, bad debts, and higher collection charges. Learn whether relaxing the credit policy aligns with Vineet Company's financial goals.

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