BUSI 320 Comprehensive Problem 2
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 $125,000 per year if credit is extended to these
new customers. Of the new accounts
receivable generated, 8% are projected to be uncollectible. Additional collection costs are projected to
be 3% of incremental sales, and production and selling costs are projected to
be 80% 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 3 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 $50,000 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.
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