Ruby Bhd., currently sells 14,600 units of product per year using a cash-only sales policy. The cost per unit is RM16 while the price per unit is RM25. Ruby Bhd., is considering switching to a net 21-day credit policy. With this credit policy, Ruby Bhd., estimates that it can sell 14,965 units per year, at the price of RM24 per unit and cost of RM14 per unit. Ruby Bhd.’s required return (EAR) on receivables is 8%.

(c) What is the NPV of Ruby Bhd., switching from the cash-only policy to the credit policy?

(d) Should Ruby Bhd., switch to the credit policy from the cash policy? Why? Explain briefly.

Ans)c) Given,

When cash sales policy is used :

Profit per unit = Selling price per unit - Cost price per unit

= 25-16 = 9

Total profit when cash sales policy is used = Profit per unit * No of units sold

= 9 * 14600 = RM131400

But company decided to switch to credit sale policy of 21 day :

Profit per unit = Selling price per unit - Cost price per unit

= 24-14 = 10

Total profit when credit sales policy is used = Profit per unit * No of units sold

= 10 * 14965 = RM 149650

Reuired rate of return (i) = 8% , t = time period

Net present value of Profit = Profit / (1+ i) ^t

⁼ 149650 / (1+0.08) ¹

⁼  149650/ 1.08 = RM 138564.81

The profit is increased from shifting of cash to credit -

Profit increased = 138564.81 (credit sales profit)  - 131400 ( cash sale profit)

= RM 7164.81.

Ans d) Yes, Ruby Bhd should switch to the credit policy from the cash policy because of the following reasons:-

1. Both the unit sold and profit has been increased . The units sold increases from 14600 units to 14965 units i.e. 365 units. The profit also increases from RM131400 to RM 138564.81 i.e. RM 7164.81.
2. The Ruby Bhd can get competitive advantage over his competitors.
3. Offering credit to the customer builds trust towards the company. Customer becomes loyal to the company .