# FINANCE

Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales will increase by $100,000 if credit is extended to these new customers. Of the new accounts receivable generated, 10 percent will prove to be uncollectible. Additional collection costs will be 3 percent of sales, and production and selling costs will be 79 percent of sales. The firm is in the 40 percent tax bracket.

* a*. Compute the incremental income after taxes.

* b*. What will Johnson’s incremental return on sales be if these new credit customers are accepted?

* c*. If the receivable turnover ratio is 6 to 1, and no other asset buildup is needed to serve the new customers, what will Johnson’s incremental return on new average investment be?

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 to support this sales expansion?

* b*. What would be Collins’s incremental aftertax return on investment?

* c*. Should Collins liberalize credit if a 15 percent aftertax return on investment is required?

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 a $80,000 increase in sales?

* e*. Given the income determined in part *b* and the investment determined in part *d*, should Collins extend more liberal credit terms?

Curtis Toy Manufacturing Company is evaluating the extension of credit to a new group of customers. Although these customers will provide $240,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur $21,000 in additional collection expense. Production and marketing costs represent 72 percent of sales. The company is in a 30 percent tax bracket and has a receivables turnover of six times. No other asset buildup will be required to service the new customers. The firm has a 10 percent desired return on investment.

* a*. Should Curtis extend credit to these customers?

* b*. Should credit be extended if 14 percent of the new sales prove uncollectible?

* c*. Should credit be extended if the receivables turnover drops to 1.5 and 12 percent of the accounts are uncollectible (as was the case in part *a*).

Reconsider problem 18. Assume the average collection period is 120 days. All other factors are the same (including 12 percent uncollectibles). Should credit be extended?

Apollo Data Systems is considering a promotional campaign that will increase annual credit sales by $600,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:

Accounts receivable……………………………… | 5x |

Inventory…………………………………………….. | 8x |

Plant and equipment…………………………….. | 2x |

All $600,000 of the sales will be collectible. However, collection costs will be 3 percent of sales, and production and selling costs will be 77 percent of sales. The cost to carry inventory will be 6 percent of inventory. Depreciation expense on plant and equipment will be 7 percent of plant and equipment. The tax rate is 30 percent.

* a*. Compute the investments in accounts receivable, inventory, and plant and equipment based on the turnover ratios. Add the three together.

* b*. Compute the accounts receivable collection costs and production and selling costs and add the two figures together.

* c*. Compute the costs of carrying inventory.

* d*. Compute the depreciation expense on new plant and equipment.

* e*. Add together all the costs in parts *b, c*, and *d*.

* f*. Subtract the answer from part *e* from the sales figure of $600,000 to arrive at income before taxes. Subtract taxes at a rate of 30 percent to arrive at income after taxes.

* g*. Divide the aftertax return figure in part *f* by the total investment figure in part *a*. If the firm has a required return on investment of 12 percent, should it undertake the promotional campaign described throughout this problem.

In Problem 20, if inventory turnover had only been 4 times:

* a*. What would be the new value for inventory investment?

* b*. What would be the return on investment? You need to recompute the total investment and the total costs of the campaign to work toward computing income after taxes. Should the campaign be undertaken?

Maddox Resources has credit sales of $180,000 yearly with credit terms of net 30 days, which is also the average collection period. Maddox does not offer a discount for early payment, so its customers take the full 30 days to pay.

What is the average receivables balance? What is the receivables turnover?

If Maddox were to offer a 2 percent discount for payment in 10 days and every customer took advantage of the new terms, what would the new average receivables balance be? Use the full sales of $180,000 for your calculation of receivables.

24. If Maddox reduces its bank loans, which cost 12 percent, by the cash generated from its reduced receivables, what will be the net gain or loss to the firm?

Assume that the new trade terms of 2/10, net 30 will increase sales by 20 percent because the discount makes the Maddox price competitive. If Maddox earns 16 percent on sales before discounts, should it offer the discount? (Consider the same variables as you did for problems 22 through 24.)