Slow Roll Drum Co. is evaluating the extension of credit to a new group of custo

Question

Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur $16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket. No other asset buildup will be required to service the new customers. The firm has a 10 percent desired return. Assume the average collection period is 120 days.

Explanation / Answer

Sales 180,000

Less: Production and marketing at 72% 129,600

Bad debt expense at 12% 21,600

Addl Collection expenses 16,200

Pre tax incomr 12,600

Taxes at 34% 4284

Income after tax 8316

% of sales 4.62%

You don't say what the desired return of 10% is on, but assuming it is sales this doesn't work.

If it is on increased assets, receivables turn 360/120 or 3 times a year so the average investment is 180,000/3= 60,000.

8316/60,000= 13.86% then it does work.

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