Question

Carlo’s Body Shop has been having some trouble collecting its accounts receivable. Carlo is considering asking his Godfather Vito for some help with collections. Carlo has provided the following information:

Annual credit sales	$1,800,000
The current average collection period	30 days
Average collection period with Vitos "help"	1 day
Percentage of sales lost with Vitos "help"	2%
Vito's annual fee	$50,000
Carlos return on assets	20%
Carlos profit margin	8%

Answer 1

Assuming all sales are credit sales

Profit margin currently = 8% of $1,800,000 = $144,000

Return on assets = 20%

Assets = $144,000 / 0.2 = $720,000

With Veto's help -

Sales will reduce to 98% of $1,800,000 = $1,764,000

Profit margin before Vito's fee = 8% of $1,764,000 = $141,120

Profit after Vito's fee = $91,120

New Profit Margin = ($91,120 / $1,764,000)*100 = 5.17%

New Return on Assets = ($91,120 / $720,000)*100 = 12.66%

By taking Vito's help Carlo will have a decline of 2.83% decline in profit margin and 7.34% in return on assets for the benefit of 1 day credit collection period