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Chapter 3: 18BP_b (page 223)

Henderson Office Supply 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 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

b. What would be Henderson鈥檚 incremental after-tax return on investment?

Short Answer

Expert verified

The incremental after-tax return on investment is 35.2%.

Step by step solution

01

Information provided in the question

Increase in sales = $65,000

Production and selling costs = 74%

Uncollectible accounts = 9%

Collection costs = 6%

Income taxes = 20%

Accounts receivables turnover = 4 times

02

Calculation of incremental income after taxes

The incremental income after taxes is $5,720.

Particulars

Amount

Additional sales

$65,000

Accounts uncollectible (9% of additional sales)

($5,850)

Annual incremental revenue

$59,150

Collection costs (6% of additional sales)

($3,900)

Production and selling costs (74% of additional sales)

($48,100)

Annual income before taxes

$7,150

Taxes (20%)

($1,430)

Incremental income after taxes

$5,720

03

Calculation of incremental after-tax return on investment

The incremental after-tax return on investment is 35.2%.

Incrementalafter-taxreturnoninvestment=IncrementalincomeInvestmentinreceivables脳100=$5,720$16,250脳100=35.2%

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Most popular questions from this chapter

Boatler Used Cadillac Co. requires $850,000 in financing over the next two years. The firm can borrow the funds for two years at 12 percent interest per year. Mr. Boatler decides to do forecasting and predicts that if he utilizes short term financing instead, he will pay 7.75 percent interest in the first year and 13.55 percent interest in the second year. Determine the total two-year interest cost under each plan. Which plan is less costly?

What advantages do compensating balances have for banks? Are the advantages to banks necessarily disadvantages to corporate borrowers?

Carmen鈥檚 Beauty Salon has estimated monthly financing requirements for the next six months as follows:

January

\(8,500

February

\)2,500

March

\(3,500

April

\)8,500

May

\(9,500

June

\)4,500

Short-term financing will be utilized for the next six months.

January

9%

February

10%

March

13%

April

16%

May

12%

June

12%

Here are the projected annual interest rates:

a. Compute total dollar interest payments for the six months. To convert an annual rate to a monthly rate, divide by 12. Then multiply this value times the monthly balance. To get your answer, add up the monthly interest payments.

b. If long-term financing at 12 percent had been utilized throughout the six months, would the total-dollar interest payments be larger or smaller? Compute the interest owed over the six months and compare your answer to that in part a.

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm鈥檚 checks will take longer to clear the bank. Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.

b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear鈥檚 earnings before interest and taxes are \)240,000. Determine Lear鈥檚 earnings after taxes under this financing plan. The tax rate is 30 percent.
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