FIN 200

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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?

Accounts Receivable = $16000

b. What would be Collins’s incremental after-tax return on investment?

Additional 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
Annual incremental income after taxes……………….$4,480

Return On Investment = 28%

c. Should Collins liberalize credit if a 15 percent after-tax 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.

Collins should liberalize credits if a 15% after-tax return on investments is required because Collins would see a 28% return on investments.

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

$20,000

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

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