Question

Global Services is considering a promotional campaign that will increase annual credit sales by $440,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:  
  

Accounts receivable	4	times
Inventory	4	times
Plant and equipment	2	times

     
All $440,000 of the sales will be collectible. However, collection costs will be 5 percent of sales, and production and selling costs will be 73 percent of sales. The cost to carry inventory will be 5 percent of inventory. Depreciation expense on plant and equipment will be 5 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.
  

    

b. Compute the accounts receivable collection costs and production and selling costs and then add the two figures together.
  

   

c. Compute the costs of carrying inventory.
  

   

d. Compute the depreciation expense on new plant and equipment.
  

     

e. Compute the total of all costs from parts b through d.
  

   

f. Compute income after taxes.
  

   

g-1. What is the aftertax rate of return? (Input your answer as a percent rounded to 2 decimal places.)
  

    

g-2. If the firm has a required return on investment of 12 percent, should it undertake the promotional campaign described throughout this problem?
  

	No
	Yes

Answer 1

Solution:
Given:
Annual credit sales	$440000
Accounts Receivable Turnover	4 Times
Inventory Turnover	4 Times
Plant and Equipment Turnover	2 Times
Collection cost	5% of sales
Production and selling cost	73% of sales
Cost to carry Inventory	5% of Inventory
Depreciation	5% of Plant and Equipment
Tax rate	35%
a)
Accounts Receivable = Sales/Account Receivable Turnover
$440000/4
110000
Accounts Receivable = $110000
Inventory:
Inventory = Sales/Inventory Turnover
$440000/4
110000
Inventory = $110000
Plant and Equipment:
Plant and Equipment = Sales/Plant and Equipment turnover
$440000/2
220000
Plant and Equipment = $220000
Total Investment = Accounts Receivable + Inventory + Plant and Equipment
$110000+$110000+$220000
440000
Total Investment = $440000
b)
Collection Cost
Collection Cost = Sales* Collection cost
$440000*5%
22000
Collection Cost =$22000
Production and selling Cost :
Production and selling Cost = Sales * Production and selling cost
$440000*73%
321200
Production and selling Cost =$321200
Total Collection,production and selling cost:
Collection Cost + Production and selling Cost
$22000+$321200
343200
Total Collection,production and selling cost= $343200
c)
Inventory carrying cost
Inventory *Inventory carying cost
$110000*5%
5500
Inventory carrying cost= $5500
d)
Depreciation expense:
Plant and Equipment* Depreciation rate
$220000*5%
11000
Depreciation expense = $11000
e) Total of all Cost
Total Collection,production and selling cost	$343200
Inventory carrying cost	$5500
Depreciation expense	$11000
Total of all Cost	$359700
f)
Sales	$440000
Less:Total Costs	$359700
Income before tax	$80300
Less:Income tax @ 35%	$28105
Income after tax	$52195
g-1)
After tax rate of return :
After tax rate of return = Income after taxes/Total Investments
$52195/$440000*100
11.8625
After tax rate of return = 11.86%
g-2
No; The aftertax rate of return of 11.86 percent is less than the required return of 12 percent,
so it should not undertake the promotional campaign