Problem 7-22 Comiskey Fence Co. is evaluating extending credit to a new group of customers. Although...

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Problem 7-22 Comiskey Fence Co. is evaluating extending credit to a new group of customers. Although these customers will pro

b-1. Calculate the incremental income before taxes from the new group of customers if 17 percent of the sales prove uncollect

C-1. Calculate the return on incremental Investment if the receivables turnover drops to 1.6 and 14 percent of the accounts a

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Answer 1

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Solution

Comiskey Fence Co

a-1. calculation of the incremental income before taxes from this new group of customers:

Sales	$216,000
Less: uncollectibles, 14% x 216,000	$30,240
Less: collection expenses	$16,400
Less: production and marketing expenses	$155,520	216,000 x 72%
Total expenses	$202,160
Income before taxes	$13,840

a-2. calculation of return on incremental investment:

return on incremental investment = income before taxes/investment in accounts receivable

investment in accounts receivable = incremental sales/receivables turnover

incremental sales = 216,000

receivables turnover = 5

investment in accounts receivable = 216,000/5 = $43,200

return on incremental investment = 13,840/43,200 = 32.04%

a-3. Yes

b-2. calculation of incremental income before taxes from the new group of customers if 17% of sales prove uncollectible:

Sales	$216,000
Less: uncollectibles, 17% x 216,000	$36,720
Less: collection expenses	$16,400
Less: production and marketing expenses	$155,520	216,000 x 72%
Total expenses	$208,640
Income before taxes	$7,360

b-2. return on incremental investment:

return on incremental investment = income before taxes/investment in accounts receivable

investment in accounts receivable = incremental sales/receivables turnover

incremental sales = 216,000

receivables turnover = 5

investment in accounts receivable = 216,000/5 = $43,200

return on incremental investment = 7,360/43,200 = 17.04%

b-3. Yes

Explanation:

The return on incremental investment, 17.04% is higher than the company’s desired rate of return on investment is 16%.

c-1. calculation of return on incremental revenue when receivables turnover drops to 1.6 times and uncollectibles = 14%

Sales	$216,000
Less: uncollectibles, 14% x 216,000	$30,240
Less: collection expenses	$16,400
Less: production and marketing expenses	$155,520	216,000 x 72%
Total expenses	$202,160
Income before taxes	$13,840

return on incremental investment:

return on incremental investment = income before taxes/investment in accounts receivable

investment in accounts receivable = incremental sales/receivables turnover

incremental sales = 216,000

receivables turnover = 1.6

investment in accounts receivable = 216,000/1.6 = $135,000

return on incremental investment = 13,840/135,000 = 10.25%

c.2. No

explanation: credit should not be extended. The return on incremental investment is less than the company’s minimum required rate of return of 12%.

Pb. 7.23

Computation of the return on incremental investment:

Average collection period = 72 days

Receivables turnover = 365days/72 days = 5.07

Investment in accounts receivables = 216,000/5.07 = $42,604

Return on incremental investment = 13,840/42,604

= 32.49%

Yes, credit should be extended.

Explanation – the return on incremental investment is higher than the company’s desired return on investment of 16%.

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