Question

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 7 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 78 percent, and the accounts receivable turnover is five times. Assume income taxes of 30 percent and an increase in sales of $69,000. No other asset buildup will be required to service the new accounts.

a. What additional investment in accounts receivable is needed to support this sales expansion?

b. What would be Henderson’s incremental aftertax return on investment? (Input your answer as a percent rounded to 2 decimal places.)

c. Should Henderson liberalize credit if a 15 percent aftertax return on investment is required? Yes No Assume that Henderson also needs to increase its level of inventory to support new sales and that the inventory turnover is three times.

d. What would be the total incremental investment in accounts receivable and inventory needed to support a $69,000 increase in sales?

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms? Yes No

Answer 1

a) Accounts Receivable Turnover = Sales/Accounts Receivable

Therefore, Additional Investment in Accounts Receivable = Additional Sales/Accounts Receivable Turnover

= $69,000/5

= $13,800

b)

Incremental after tax return on Investment = Income after tax/Investment in accounts receivable

= 4830/13800 = 35.00%

c) Yes. Because after tax return on investment (35%) is greater than required return (15%)

d) Incremental investment in inventory = Incremental Sales/Inventory Turnover

= 69000/3 = $23,000

Total Incremental Investment = 13800 + 23000 = $36,800

e) Income = $4,830

Investment = $36,800

ROI = 4830/36800 = 13.125%

No. Because after tax return on investment (13.125%) is less than required return (15%)