Proposal #1 would extend trade credit to some customers that previously have bee
ID: 2337990 • Letter: P
Question
Proposal #1 would extend trade credit to some customers that previously have been denied credit because they were considered poor risks. Sales are projected to increase by $150,000 per year if credit is extended to these new customers. Of the new accounts receivable generated, 7% are projected to be uncollectible. Additional collection costs are projected to be 3% of incremental sales (whether they actually end up collected or not), and production and selling costs are projected to be 80% of sales. Your firm expects to pay a total of 40% of its income after expenses in taxes.
1)Compute the incremental income after taxes that would result from these projections:
2)Compute the incremental Return on Sales if these new credit customers are accepted:
If the receivable turnover ratio is expected to be 3 to 1 and no other asset buildup is needed to serve the new customers…
3)Compute the additional investment in Accounts Receivable
4)Compute the incremental Return on New Investment
5)If your company requires a 20% Rate of Return on Investment for all proposals, do the numbers suggest that trade credit should be extended to these new customers? Explain.
Explanation / Answer
A Increase in sales $150,000 B=0.07*A Amount expected to be Uncollectable $10,500 C=0.03*A Additional collection cost $4,500 D=A-B-C Net Increase in sales Revenue $135,000 E=0.8*A Increase in production and selling cost $120,000 F=D-E Increase in before tax income $15,000 G=0.4*F Tax expense $6,000 1) H=F-G Incremental income after taxes $9,000 2) I=H/A IncrementalReturn on Sales 0.06 IncrementalReturn on Sales(percentage) 6% J Receivable turnover Ratio 3 Receivable turnover Ratio=Sales/Accounts Receivable 3) K=A/J Additional investment in Accounts receivable $50,000 4) L=H/K Incremental return on new investment 0.18 Incremental return on new investment(Percentage) 18% 5) Trade should not be extended to these new customers Because return on investment is less than required return of 20%
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