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Chapter 3: 20BP_a (page 224)

Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide \(180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur \)16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket. No other asset build-up will be required to service the new customers. The firm has a 10 percent desired return. Assume the average collection period is 120 days.

a. Compute the return on incremental investment.

Short Answer

Expert verified

The return on incremental investment is 7.92%.

Step by step solution

01

Information provided in the question

Increase in sales = $180,000

Production and marketing costs = 72%

Uncollectible accounts = 15%

Collection costs = $16,200

Income taxes = 34%

Accounts receivables turnover = 4 times

02

Calculation of incremental income after taxes

The incremental income after taxes is $4,752.

Particulars

Amount

Additional sales

$180,000

Accounts uncollectible (12% of additional sales)

($27,000)

Annual incremental revenue

$153,000

Collection costs

($16,200)

Production and marketing costs (72% of additional sales)

($129,600)

Annual income before taxes

$7,200

Taxes (34%)

($2,448)

Incremental income after taxes

$4,752

03

Calculation of accounts receivables

The accounts receivables is $60,000.

Accountsreceivables=Averagecollectionperiod脳Averagedailysales=120脳$180,000360=120脳$500=$60,000

04

Calculation of incremental after-tax return on investment

The incremental after-tax return on investment is 7.92%.

Incrementalafter-taxreturnoninvestment=IncrementalincomeInvestmentinreceivables脳100=$4,752$60,000脳100=7.92%

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Most popular questions from this chapter

Esquire Products Inc. expects the following monthly sales:

January

\(28,000

February

\)19,000

March

\(12,000

April

\)14,000

May

\(8,000

June

\)6,000

July

\(22,000

August

\)26,000

September

\(29,000

October

\)34,000

November

\(42,000

December

\)24,000

Total annual sales

\(264,000

Cash sales are 40 percent in a given month, with the remainder going into accounts receivable. All receivables are collected in the month following the sale. Esquire sells all of its goods for \)2 each and produces them for \(1 each. Esquire uses level production, and average monthly production is equal to annual production divided by 12.

c. Determine a cash payments schedule for January through December. The production costs (\)1 per unit produced) are paid for in the month in which they occur. Other cash payments (besides those for production costs) are $7,400 per month.

Fisk Corporation is trying to improve its inventory control system and has installed an online computer at its retail stores. Fisk anticipates sales of 49,000 units per year, an ordering cost of \(8 per order, and carrying costs of \)1.60 per unit.

b. How many orders will be placed during the year?

Commercial paper may show up on corporate balance sheets as either a current asset or a current liability. Explain this statement.

Antonio Banderos & Scarves make headwear that is very popular in the fall-winter season. Units sold are anticipated as follows:

October

1,250

November

2,250

December

4,500

January

3,500

Total units

11,500

If seasonal production is used, it is assumed that inventory will directly match sales for each month and there will be no inventory build-up.

However, Antonio decides to go with level production to avoid being out of merchandise. He will produce the 11,500 items over four months at a level of 2,875 per month.

a. What is the ending inventory at the end of each month? Compare the units sales to the units produced and keep a running total.

b. If the inventory costs $8 per unit and will be financed at the bank at a cost of 12 percent, what is the monthly financing cost and the total for the four months? (Use 1 percent or the monthly rate.)

Esquire Products Inc. expects the following monthly sales:

January

\(28,000

February

\)19,000

March

\(12,000

April

\)14,000

May

\(8,000

June

\)6,000

July

\(22,000

August

\)26,000

September

\(29,000

October

\)34,000

November

\(42,000

December

\)24,000

Total annual sales

\(264,000

Cash sales are 40 percent in a given month, with the remainder going into accounts receivable. All receivables are collected in the month following the sale. Esquire sells all of its goods for \)2 each and produces them for \(1 each. Esquire uses level production, and average monthly production is equal to annual production divided by 12.

e. Determine total current assets for each month. Include cash, accounts receivable, and inventory. Accounts receivable equal sales minus 40 percent of sales for a given month. Inventory is equal to ending inventory (part a) times the cost of \)1 per unit.
See all solutions

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