May 2020 Q5 b.

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on only cash basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

• Cost of sales 55% of sales
• Staff cost 10% of sales
• Marketing and distribution cost 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit and a new credit department is set up to assess and monitor this credit sales. The monthly cost of running this credit department is GH¢20,000 and bad debts is expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:
i) Calculate the total profit before tax before the introduction of the new policy. (4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy. (6 marks)

iii) Advise management whether the initiative should be undertaken. (3 marks)