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Checkpoint- Credit Policy Decisions

# Checkpoint- Credit Policy Decisions - Return on investment...

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17. Collins Office Supplies is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 78 percent, and accounts receivable turnover is five times. Assume income taxes of 30 percent and an increase in sales of \$80,000. No other asset buildup will be required to service the new accounts. a. What is the level of accounts receivable needed to support this sales expansion? Account receivables turnover = Sales / account receivable 5 = 80000/ account receivable Account receivable = 16000 b. What would be Collins’s incremental after tax return on investment? Sales 80000 Less: Production costs 62400 Less: Collection expenses 4000 Less: uncollectible account receivables (9% of 16000) 1440 Net income before tax 12160 Less: Taxes 3648 Net Income 8512

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Unformatted text preview: Return on investment = net Income/ Account receivables = 8512 / 16000 = 53.2% c. Should Collins liberalize credit if a 15 percent after tax return on investment is required? Yes Collins should consider the liberal credit policy Assume Collins also needs to increase its level of inventory to support new sales and that inventory turnover is four times. d. What would be the total incremental investment in accounts receivable and inventory to support an \$80,000 increase in sales? Investment in inventory = 80000 /4 = 20000 Total incremental investment Inventory \$20,000 Accounts receivable 16,000 Incremental investment \$36,000 e. Given the income determined in part b and the investment determined in part d, should Collins extend more liberal credit terms? ROI = net income / Investment = 8512 /36000 = 23.64% Yes Collins should still consider the investment...
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