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Global Services is considering a promotional campaign that will increase annual credit sales by \(450,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:

Accounts receivable	2X
Inventory	6X
Plant and equipment	1X

All \)450,000 of the sales will be collectible. However, collection costs will be 6 percent of sales, and production and selling costs will be 71 percent of sales. The cost to carry inventory will be 4 percent of inventory. Depreciation expense on plant and equipment will be 5 percent of plant and equipment. The tax rate is 30 percent.

g. Divide the after-tax return figure in part f by the total investment figure in part a. If the firm has a required return on investment of 8 percent, should it undertake the promotional campaign described throughout this problem?

Step by step solution

01

Calculation of return on investment

The return on investment is 38.15%.

$\begin{array}{rcl}\mathrm{Return}\mathrm{on}\mathrm{investment}& =& \frac{\mathrm{After}\mathrm{tax}\mathrm{income}}{\mathrm{Total}\mathrm{investment}}×100\\ & =& \frac{\$286,125}{\$750,000}×100\\ & =& 38.15\%\end{array}$

02

Decision for undertaking the promotional campaign

The company has a required rate of return on investment of 8% and the company will undertake the campaign if it has a higher rate of return than the required rate. Since, the return on investment of the campaign is 38.15%, the company should undertake the promotional campaign.

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