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 after tax return on investment?

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.

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?

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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 after tax return on investment?

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.

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?

a. To calculate the level of accounts receivable needed to support the sales expansion, we need to calculate the increase in sales and then multiply it by the accounts receivable turnover.

1. Calculate the increase in sales: $80,000
2. Calculate the accounts receivable turnover: 5
3. Multiply the increase in sales by the accounts receivable turnover: $80,000 * 5 = $400,000

Therefore, the level of accounts receivable needed to support this sales expansion is $400,000.

b. To calculate Collins's incremental after-tax return on investment, we need to consider the profit margin on the increased sales, the collection costs, and the income taxes.

1. Calculate the profit margin on the increased sales: (1 - production and selling costs - collection costs) = 1 - 78% - 5% = 17%
2. Calculate the profit on the increased sales: $80,000 * 17% = $13,600
3. Calculate the income before taxes: $13,600 * (1 - income taxes) = $13,600 * (1 - 30%) = $13,600 * 70% = $9,520

Therefore, Collins's incremental after-tax return on investment is $9,520.

c. To determine if Collins should liberalize credit, we need to compare the after-tax return on investment to the required rate of return of 15%.

1. Compare the after-tax return on investment to the required rate of return: $9,520 / ($400,000 + inventory investment) * 100 = ROI
2. If the ROI is higher than 15%, then Collins should liberalize credit. Otherwise, they should not.

d. To calculate the total incremental investment in accounts receivable and inventory, we need to calculate the inventory investment.

1. Calculate the inventory turnover: 4
2. Multiply the increase in sales by the inventory turnover: $80,000 * 4 = $320,000
3. Add the accounts receivable investment and the inventory investment to get the total incremental investment: $400,000 + $320,000 = $720,000

Therefore, the total incremental investment in accounts receivable and inventory to support an $80,000 increase in sales is $720,000.

e. To determine if Collins should extend more liberal credit terms, we need to compare the after-tax return on investment to the income and investment calculated in parts b and d.

1. Compare the after-tax return on investment to the income and investment: If the after-tax return on investment is higher than the income and investment, then Collins should extend more liberal credit. Otherwise, they should not.