Question

Mountain Home Systems, Inc. is debating whether to expand its sales in a new market. Sales are currently $5,000,000 annually, but MHS Inc. expects sales to increase to $7,000,000 annually if it enters this market.   MHS Inc. also knows that 15% of its sales are ultimately be uncollectible. In addition, collection costs will be 2% of sales and the firm's production costs are 72% of sales. Selling expenses are 8% of sales and Mountain Home has an opportunity cost of funds (before tax) of 20%. Mountain Home can turn its receivables 5 times per year. Should Mountain Home Systems Co. enter the new market?

The incremental contribution margin is:

560,000

1,400,000

1,440,000

1,960,000

The incremental bad debt expense is:

(300,000)

300,000

1,050,000

(1,050,000)

The incremental selling expenses are:

(160,000)

(400,000)

560,000

(560,000

The change in accounts receivable is:

400,000

(400,000)

1,400,000

(1,400,000)

Answer 1

Here, as per the requirements,we will take the incremental figures. Incremental means the increased or additional figures.

1. For calculating incremental contribution margin, we have to calculate the incremental sales and incremental variable costs.

Additional or incremental sales = $7000000 - $5000000

= $2000000

Incremental variable costs = Incremental sales * 72%

= $2000000 * 72%

= $1440000

Incremental contribution margin = Incremental sales - Incremental variable costs

= $2000000 - $1440000

= $560000

2. Incremental bad debt expense = Uncollectible accounts on incremental sales

= 15% of $2000000

= ($300000). since it is increase in expense, so we will take it as negative figure.

3. Incremental selling expenses = Selling costs on additional sales

= 8% on $2000000

= ($160000) since it is increase in expense, so we will take it as negative figure.

4. Change in accounts receivable = Additional sales / Accounts receivables turnover

= $2000000 / 5

= $400000, since there is increase in accounts receivables, so we will take positive value.