question archive Henderson Office Supplies is considering a more liberal credit policy to increase sales, but it expects that 6 percent of the new accounts will be uncollectible
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Henderson Office Supplies is considering a more liberal credit policy to increase sales, but it expects that 6 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production costs are 80 percent of sales, and accounts receivable turnover is five times. Assume an increase in sales of $74,000. No other asset buildup will be required to service the new accounts.
a. What is the level of investment in accounts receivable to support this sales expansion?
Investment in accounts receivable _________ $
b. What would be Henderson's incremental before?tax return on investment?
Return on incremental investment _________ %
c. Should Henderson liberalize credit if a 30 percent before?tax return is required (opportunity cost of capital)?
multiple choice 1
Assume Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is five times on Cost of Goods Sold.
d. What would be the total incremental investment in accounts receivable and inventory to support a $74,000 increase in sales?
Total incremental investment ________$
e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?
multiple choice 2
Henderson Office Supplies is considering a more liberal credit policy to increase sales, but it expects that 6 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production costs are 80 percent of sales, and accounts receivable turnover is five times. Assume an increase in sales of $74,000. No other asset buildup will be required to service the new accounts.
a. What is the level of investment in accounts receivable to support this sales expansion?
Investment in accounts receivable _______ $
b. What would be Henderson's incremental before?tax return on investment?
Return on incremental investment _________ %
c. Should Henderson liberalize credit if a 30 percent before?tax return is required (opportunity cost of capital)?
multiple choice 1
Assume Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is five times on Cost of Goods Sold.
d. What would be the total incremental investment in accounts receivable and inventory to support a $74,000 increase in sales?
Total incremental investment ________ $
e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?
multiple choice 2
a) Computation of Investment in accounts receivable:
Investment in accounts receivable = $74,000/5 = $14,800
b) Computation of Return on incremental investment:
Please see the attachment...
Return on incremental investment = Incremental income after taxes/Investment in accounts receivable
= $4,662/$14,800
Return on incremental investment = 31.50%
c) Yes, Henderson should liberalize credit if a 30 percent before?tax return is required (opportunity cost of capital) as Return on incremental investment is higher.
d) Please see the attachment..
e) No, Henderson should not liberalize credit because 15.75% return is less than the required return of 30%.
Note: As Tax rate is not provided in question, So i have assumed 30% tax rate.