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Chapter 3: 17BP_c (page 223)

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.

c. If the receivable turnover ratio is 3 to 1 and no other asset build-up is needed to serve the new customers, what will Johnson鈥檚 incremental return on new average investment be?

Short Answer

Expert verified

The incremental return on the new average return is 37.05%.

Step by step solution

01

Calculation of receivables

The receivables are $50,000.

Receivablesturnover=SalesReceivablesReceivables=SalesReceivablesturnoverReceivables=$150,0003Receivables=$50,000

02

Calculation of incremental return on new average return

The incremental return on the new average return is 37.05%.

Incrementalreturnonnewaveragereturn=IncrementalincomeReceivables脳100=$18,525$50,000脳100=37.05%

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Most popular questions from this chapter

鈥淭he most appropriate financing pattern would be one in which asset build-up and length of financing terms are perfectly matched.鈥� Discuss the difficulty involved in achieving this financing pattern.

Explain why the bad debt percentage or any other similar credit-control percentage is not the ultimate measure of success in the management of accounts receivable. What is the key consideration?

Logan Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast. Joe Logan, the president of the company, is thinking about changing the firm鈥檚 credit policy to attract customers away from competitors. The present policy calls for a 1/10, net 30 cash discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of Logan customers are taking the discount, and it is anticipated that this number would go up to 50 percent with the new discount policy. It is further anticipated that annual sales would increase from a level of \(400,000 to \)600,000 as a result of the change in the cash discount policy. The increased sales would also affect the inventory level. The average inventory carried by Logan is based on a determination of an EOQ. Assume sales of fans and heaters increase from 15,000 to 22,500 units. The ordering cost for each order is \(200, and the carrying cost per unit is \)1.50 (these values will not change with the discount). The average inventory is based on EOQ/2. Each unit in inventory has an average cost of $12. Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are 15 percent of net sales; and interest payments of 14 percent will only be necessary for the increase in the accounts receivable and inventory balances. Taxes will be 40 percent of before-tax income.

c. Complete the following income statement:

Before policy change

After policy change

Net sales (sales 鈥� cash discounts)

Cost of goods sold

Gross profit

General and administrative expenses

Operating profit

Interest on the increase in accounts receivable and inventory (14%)

Income before taxes

Taxes

Income after taxes

What does the EOQ formula tell us? What assumption is made about the usage rate for inventory?

What are three theories for describing the shape of the term structure of interest rates (the yield curve)? Briefly describe each theory.
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