Problem 20-6A - chapter 20

Problem 20-6A - chapter 20 - = (additional accounts...

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Step1 Estimate the change in Profit. = (increase sales x contribution margin) – (increased sales x percent bad debt losses on new sales) = ($1,000,000 x 0.20) – ($1,000,000 x 0.08) = 200,000 – 80,000 = 120,000 Step2 Estimate the cost of additional investments in accounts receivable and inventory. = (additional accounts receivable + additional inventory) x (pre-tax required rate of return) First, we have to calculate the additional investment in accounts receivable. Additional accounts receivable = (new level of daily sales) x (new average collection period) – (original level of daily sales) x (original average collection period) = (6,000,000 / 360 x 90) – (5,000,000 / 360 x 60) = 1,500,000 – 833333.33 = 666666.67 Now that the value of additional accounts receivable is known, we can calculate the cost of additional investments in accounts receivable and inventory. Hence, the cost of additional investments in accounts receivable and inventory.
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Unformatted text preview: = (additional accounts receivable + additional inventory) x (pre-tax required rate of return) = (666666.67 + 50,000) x (0.15) = (716666.67) x (0.15) = 107500.0000005 = 107500 (by approximating 107500.0000005) Step3 Estimate the change in the cost of the cash discount (if the change in the cash discount is in tact). = (new level of sales x new percent cash discount x percent customers taking discount) – (original level of sales x original percent cash discount x original percent taking discount) (This step is not applicable in this problem) Step 4 Compare the incremental revenues with the incremental costs. Net change in pre-tax profits = change in profits – (cost of new investment in accounts receivable and inventory + cost of change in cash discount) = Step 1 – (Step 2 + Step 3) = Step 1 – Step 2 (as Step 3 is not applicable in this problem) = 120,000 – 107,500 = 12,500...
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This note was uploaded on 08/21/2010 for the course FIN FIN370 taught by Professor Mr.garcia during the Fall '09 term at DeVry Long Beach.

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Problem 20-6A - chapter 20 - = (additional accounts...

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