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Collins Office Supplies is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 78 percent, and accounts receivable turnover is five times. Assume income taxes of 30 percent and an increase in sales of $80,000. No other asset buildup will be
required to service the new accounts.

a. What is the level of accounts receivable needed to support this sales
expansion?

b. What would be Collins’s incremental aftertax return on investment?

c. Should Collins liberalize credit if a 15 percent aftertax return on investment is required?

Assume Collins also needs to increase its level of inventory to support
new sales and that inventory turnover is four times.

d. What would be the total incremental investment in accounts receivable and
inventory to support an $80,000 increase in sales?

e. Given the income determined in part b and the investment determined in
part d, should Collins extend more liberal credit terms?

  • finance -

    a. Investment in accounts receivable =

    b. Added sales $ 80,000
    Accounts uncollectible (9% of new sales) – 7,200
    Annual incremental revenue $ 72,800
    Collection costs (5% of new sales) – 4,000
    Production and selling costs
    (78% of new sales) – 62,400
    Annual income before taxes $ 6,400
    Taxes (30%) – 1,920
    Incremental income after taxes $ 4,480

    Return on incremental investment = $4,480/$16,000 = 28%

    c. Yes! 28% exceeds the required return of 15%.

    d. Investment in inventory =

    Total incremental investment

    Inventory $20,000
    Accounts receivable 16,000
    Incremental investment $36,000

    $4,480/$36,000 = 12.44% return on investment

    e. No! 12.44% is less than the required return of 15%.

  • finance -

    THis is more of a question how did you get the inventory question in part D?

  • finance -

    answer to your question you take collection cost 5% of new sales which is 4,000 add 16,000 which is your a/c fiqure you got sales divided by a/c turnover which equal 20,000 which is your inventory..

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