You have been asked to assess the expected financial impact of each of the following proposals
to improve the profitability of credit sales made by your company. Each proposal is independent
of the other. Answer all questions. Showing your work may earn you partial credit.
Proposal #1 would extend trade credit to some customers that previously have been
denied credit because they were considered poor risks. Sales are projected to increase
by $160,000 per year if credit is extended to these new customers. Of the new accounts
receivable generated, 10% are projected to be uncollectible. Additional collection costs
are projected to be 2% of incremental sales, and production and selling costs are
projected to be 78% of sales. Your firm expects to pay a total of 40% of its income after
expenses in taxes.
1) Compute the incremental income after taxes that would result from these
projections:
2) Compute the incremental Return on Sales if these new credit customers are
accepted:
If the receivable turnover ratio is expected to be 4 to 1 and no other asset buildup
is needed to serve the new customers…
3) Compute the additional investment in Accounts Receivable
4) Compute the incremental Return on New Investment
5) If your company requires a 20% Rate of Return on Investment for all proposals, do
the numbers suggest that trade credit should be extended to these new
customers? Explain. Proposal #2 would establish local collection centers throughout the region to decrease
the time it takes to convert credit payments that are mailed in by check to cash. It is
estimated that establishing these collection centers would reduce the average collection
time by 2 days.
1) If the company currently averages $40,000 in collections per day, how many
dollars will this suggested cash management system free up? 2) If all freed up dollars would be used to pay down debt that has an interest rate
of 6%, how much money could be saved each year in interest expense?
3) Do the numbers suggest that this new system should be implemented if its
total annual cost is $5200? Explain.
ScholarMatic: Explanation & Answer
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