BUSI 320 SUMMER D Comprehensive Problem 2 You have been asked to assess the expe

Question

BUSI 320 SUMMER D Comprehensive Problem 2

You have been asked to assess the expected financial impact of each of the following proposals to improve the profitability of credit sales made by your company. Each proposal is independent of the other. Answer all questions. Showing your work may earn you partial credit.

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 $140,000 per year if credit is extended to these new customers. Of the new accounts receivable generated, 8% are projected to be uncollectible. Additional collection costs are projected to be 3% of incremental sales, 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 4 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.

Proposal #2 would establish local collection centers throughout the region to decrease the time it takes to convert credit payments that are mailed in by check to cash. It is estimated that establishing these collection centers would reduce the average collection time by 2 days.

1)If the company currently averages $45,000 in collections per day, how many dollars will this suggested cash management system free up?

2)If all freed up dollars would be used to pay down debt that has an interest rate of 7%, how much money could be saved each year in interest expense?

3)Do the numbers suggest that this new system should be implemented if its total annual cost is $5200? Explain.

Explanation / Answer

PART A Ans 1 Details Amount Amount Increase in Sales          1,40,000.00 Less Production and Selling Cost 80% of 140000          1,12,000.00 Less:Additional Collection Cost 3% of 140000                4,200.00 LessBad bebts   8% of 140000              11,200.00 Incremental Profit from Additional Sales              12,600.00 Less Tax 40% of 12600                5,040.00 Profit After Tax                7,560.00 Ans 2 Return on sales Increase in Operating Profit              12,600.00 Increase in Sales          1,40,000.00 Return on sales a/b                         0.09 Ans 3 Incremental Sales          1,40,000.00 Expected Receivable turnover ratio                         4.00 Average Investment in Receivables 140000/4              35,000.00 Ans 4 Return After Tax                7,560.00 Average Investment Required              35,000.00 Incremental Return on Investment 7560/35000                         0.22 Ans 5 Since the 22% return on investment earned is more than cut off 20% , investment additional sales is justified PART B Ans 1 Reduction in Average collection Period 2 Days Average Collection Per Day              45,000.00 Amount of $ freed up 45000*2              90,000.00 Ans2 Interest Rate                         0.07 Money Save in Interest Expense                6,300.00 Less Total Cost                5,200.00 Net Gain                1,100.00 System Should be implemeted

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