Let us know if you got a helpful answer. Question Tara\'s Textiles currently has

ID: 2721699 • Letter: L

Question

Let us know if you got a helpful answer. Question Tara's Textiles currently has credit sales of $361 million per year and an average collection period of 63 days. Assume that the price of Tara's products is $61 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable change that will result in a 20.4% increase in sales and a 19.5% increase in the average collection period. No change in bad debts is expected. The firm's equal-risk opportunity cost on its investment in accounts receivable is 13.2%. (Note: Use a 365-day year.)

a. Calculate the additional profit contribution from sales that the firm will realize if it makes the proposed change. (I calculated a. as $7,243,672)

b. What marginal investment in accounts receivable will result?

c. Calculate the cost of the marginal investment in accounts receivable.

d. Should the firm implement the proposed change? What other information would be helpful in your analysis?

Explanation / Answer

Calculation of additional profit contribution from sales that the firm will realize if it makes the proposed change:

Increase in sales ($361,000,000 *20.4%) =

$ 73,644,000.00

Less: Increase in Variable Costs ($361,000,000 *55/ 61)*20.4%

$ (66,400,327.87)

Additional profit contribution=

$ 7,243,672.13

Calculation of marginal investment in accounts receivable:

Current Sales

$ 3,610,000,000.0

Add: Increase in sales ($361,000,000 *20.4%) =

$ 73,644,000.0

Total Expected Sales =

$ 3,683,644,000.0

Current average collection period

63 Days

Increase in the average collection period = 63*19.5% =

12.29 Days

Marginal investment in accounts receivable = $3683644000*12.29 /365 =

$ 124,032,834.96

Calculation of cost of the marginal investment in accounts receivable:

Marginal investment in accounts receivable = (A)

$ 124,032,834.96

Opportunity cost on its investment in accounts receivable (B)

13.20%

Cost of the marginal investment in accounts receivable = (A*B)

$ 16,372,334.21

Firm should now implement the proposed change, because the Additional profit contribution is less than the Cost of the marginal investment in accounts receivable