Question

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although...

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $126,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $15,900 in additional collection expense. Production and marketing costs represent 70 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers. The firm has a 10 percent desired return.

a-1. Calculate the incremental income after taxes.

a-2. Calculate the return on incremental investment. (Input your answer as a percent rounded to 2 decimal places.)

a-3. Should Fast Turnstiles Co. extend credit to these customers? Yes No

b-1. Calculate the incremental income after taxes if 12 percent of the new sales prove to be uncollectible.

b-2. Calculate the return on incremental investment if 12 percent of the new sales prove to be uncollectible. (Input your answer as a percent rounded to 2 decimal places.)

b-3. Should credit be extended if 12 percent of the new sales prove uncollectible? Yes No

c-1. Calculate the return on incremental investment if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible. (Input your answer as a percent rounded to 2 decimal places.)

c-2. Should credit be extended if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible?

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Answer #1

a-1.

Added sales $126,000

Less : Uncollectible accounts $11,340

Incremental revenue $114,660

Collection costs $15,900

Production and selling costs $88,200

Incremental income before taxes $10,560

Taxes $3,696

Incremental income after taxes $6,864

Uncollectible accounts = .09 ×$126,000 = $11,340

Production and selling costs = .70 ×$126,000 = $88,200

Taxes = .35 ×$10,560 = $3,696

a-3. yes

b-1. incremental income after taxes if 12 percent of the new sales prove to be uncollectible

Added sales $126,000

Less : Uncollectible accounts $15,120

Incremental revenue $110,880

Collection costs $15,900

Production and selling costs $88,200

Incremental income before taxes $6,780

Taxes   $2,373

Incremental income after taxes $4,407

Uncollectible accounts = .12 ×$126,000 = $15,120

Production and selling costs = .70 ×$126,000 = $88,200

Taxes = .35 ×$6,780 = $2,373

b-3. yes

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