Answer: See explanation
Explanation:
a. Compute the incremental income after taxes that would result from these projections:
Sales increase= $200,000
Less: Uncollectible accounts:
= 7% × $200,000
= ($14,000)
Annual incremental value= $186,000
Less: Collection cost:
= 3% × $200,000
= ($6000)
Less: Production and selling cost:
= 80% × $200,000
= ($160,000)
Incremental income before tax= $20000
Tax at 30% = ($6000)
Incremental income after tax = $14000
b. Compute the incremental Return on Sales if these new credit customers are accepted If the receivable turnover ratio is expected to be 4 to 1 and no other asset buildup is needed to serve the new customer.
Incremental Return on Sales will be:
= Incremental income after taxes ÷ Increase in sales
= $14000/$200000
= 7%
c. Compute the additional investment in Accounts Receivable.
Since the receivable turnover ratio will be 4, then the additional investment in the accounts receivable will be:
= Additional credit sales/Receivable turnover ratio
= $200000 /4
= $50,000
Therefore, the additional investment in the accounts receivable will be $50,000.
d. Compute the incremental Return on New Investment.
The incremental return on new investment will be:
= Incremental income after taxes/Additional investment
= $14000/$50000
= 28%
e. 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.
Yes, the numbers implies that trade credit should be extended to these new customers. This is because the incremental return on the new investment is 28%, and this is higher than the rate of return on investment which is 20%.
