Question

Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $150,000 if credit is extended to these new customers. Of the new accounts receivable generated, 5 percent will prove to be uncollectible. Additional collection costs will be 2 percent of sales, and production and selling costs will be 74 percent of sales. The firm is in the 35 percent tax bracket.

  

a.	Compute the incremental income after taxes.

  

Incremental income after taxes

$

  

b.	What will Johnson’s incremental return on sales be if these new credit customers are accepted? (Input your answer as a percent rounded to 2 decimal places.)

  

Incremental return on sales

%

c.	If the accounts receivable turnover ratio is 3 to 1, and no other asset buildup is needed to serve the new customers, what will Johnson’s incremental return on new average investment be? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

  

Incremental return on new average investment

%

Answer 1

(a) Computation of incremental income after taxes

Particulars Additional Sales less :-Accounts uncolectible (5% of new sales) Annual Incremental Revenue less:-Collection Costs (2%) less :-Production & Selling Costs (74% of new sales) Annual Income before taxes Taxes (35%) Incremental Income after taxes Amount $ 150,000 $7,500 $ 142,500 $3,000 $ $28,500 $9,975 $ 18,525 111,000

(b)

Incremental return on sales = Incremental income / Incremental Sales

Incremental return on sales = $18,525 / $150,000

Incremental return on sales = 0.1235 or 12.35%

(c)

Receivable turnover = Sales / Receivable turnover = 6X

Receivables = Sales / Receivable turnover

Receivables = $150,000 / 6

Receivables = $25,000

Incremental return on new average investment = $18,525 / $25,000

Incremental return on new average investment = 0.741 or 74.10%