You have been asked to assess the expected financial impact of each of the follo

Question

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.

Type your answers in the table and submit this worksheet. Showing your work may earn you partial credit. If you wish to show your work, please do so under each question below the table.

Your Answers:

Proposal #1

1

2

3

4

5

Proposal #2

1

2

3

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.

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 $60,000 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 6%, 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.

Your Answers:

Proposal #1

1

2

3

4

5

Proposal #2

1

2

3

Explanation / Answer

Proposal # 1 1 Compute the incremental income after taxes that would result from these projections Increase in Sales $150,000 Less : Uncollectible @ 7% $10,500 Collection Costs @ 3% $4,500 Production and Selling Costs @ 80% $120,000 Profit before taxes $15,000 Tax @ 40% $6,000 Incremental income after taxes $9,000 2 Compute the incremental Return on Sales if these new credit customers are accepted Incremental return on Sales = $9000/$150000 6% 3 Compute the additional Investment in Accounts Receivable Incremental Sales/Receivable Turnover ratio $150000/3 50000 Additional Investment in Accounts Receivable - $50000 4 Compute the incremental return on New Investment Incremental return 9900/50000 Incremental return on new Investment 19.80% 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. No, the company should not take this project since the rate of return on investment is less than 20% that is 19.80% Proposal # 2 1 If the company currently averages $60,000 in collections per day, how many dollars will this suggested cash management system free up? $60000*2 $120,000 Cash management system free up - $120000 2 If all freed up dollars would be used to pay down debt that has an interest rate of 6%, how much money could be saved each year in interest expense? $60000*6% $3,600 3 Do the numbers suggest that this new system should be implemented if its total annual cost is $5200? Explain. Yes, since the annual cost is less than $ 5200 that is $3600

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