Global Services is considering a promotionaampaign that will increase annual cre

Question

Global Services is considering a promotionaampaign that will increase annual credit sales by $500,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows: Accounts receivable Inventory Plant and equipment 4 times 8 times 2 times All $500,000 of the sales will be collectible. However, collection costs will be 6 percent of sales, and production and selling costs will be 70 percent of sales. The cost to carry inventory will be 8 percent of inventory. Depreciation expense on plant and equipment will be 15 percent of plant and equipment. The tax rate is 35 percent. a. Compute the investments in accounts receivable, inventory, and plant and equipment based on the turnover ratios. Add the three together. Accounts receivable Inventory Plant and equipment Total Investment

Explanation / Answer

a)

Accounts receivable ratio = 4 times

Credit sales = 500000

Accounts receivable = Credit sales/Accounts receivable ratio = 500000/4 = 125000

Inventory Turnover = 8 times

Inventory = Credit sales /Inventory Turnover ratio = 500000/8 = 62500

Plant and Equipment turnover = 2 times

Plant and Equipment = Credit sales /Plant and Equipment turnover = 500000/2 = 250000

Total investment = 125000+62500+250000 = 437500

b)

Collection cost = Credit Sales*6% = 500000*6% = 30000

Production and selling costs = Credit Sales*70% = 500000*70% = 350000

Total = 30000+350000 = 380000

c)

Cost of carrying inventory = Inventory value *8% = 62500*8% = 5000

d)

Depreciation expense on plant and Equipment = 15%*Plant and equipment = 15%*250000 = 37500

e)

Total costs = b+c+d = 380000+5000+37500 = 422500

f)

Income befor taxes = 500000 - 422500 = 77500

Income after taxes = 77500*(1-0.35) = 77500*0.65 = 50375

g-1)

After tax rate of return = [50375/437500] *100 = 11.51%

g-2)

No

(because required rate is 12% but actual rate of return is 11.51%)

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