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 $200,000 per year if credit is extended to these new customers. Of the new accounts receivable generated, 6% are projected to be uncollectible. Additional collection costs are projected to be 5% of incremental sales, and production and selling costs are projected to be 78% of sales. Your firm expects to pay a total of 30% of its income after expenses in taxes. (Please show work)
Answer 1:
Incremental Income after tax = $15,400
Working:
Answer 2:
Incremental Return on Sales = 7.7%
Working:
Incremental Return on Sales = 15400 / 200000 * 100 = 7.7%
Answer 3:
Additional investment in Accounts Receivable = $40,000
Working:
Additional investment in Accounts Receivable = Sales / receivable turnover ratio = 200000 / 5 = $40,000
Answer 4:
Incremental return on new investment = 15400 / 40000 = 38.5%
Answer 5:
Yes,
Trade credit should be extended to these new customers.
Incremental return on new investment is greater than required rate of return of 20%.
You have been asked to assess the expected financial impact of each of the following proposals...
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