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Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although...

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $126,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $15,900 in additional collection expense. Production and marketing costs represent 70 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers. The firm has a 10 percent desired return.  

a-1. Calculate the incremental income after taxes.  
  

    

a-2. Calculate the return on incremental investment. (Input your answer as a percent rounded to 2 decimal places.)
  

   

a-3. Should Fast Turnstiles Co. extend credit to these customers?
  

Yes
No

  

b-1. Calculate the incremental income after taxes if 12 percent of the new sales prove to be uncollectible.
  

   

b-2. Calculate the return on incremental investment if 12 percent of the new sales prove to be uncollectible. (Input your answer as a percent rounded to 2 decimal places.)
  

     

b-3. Should credit be extended if 12 percent of the new sales prove uncollectible?
  

Yes
No

  

c-1. Calculate the return on incremental investment if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible. (Input your answer as a percent rounded to 2 decimal places.)
  

   

c-2. Should credit be extended if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible?

Solutions

Expert Solution

a-1) Fast Turnstiles Co.

Added Sales                                                                                       $126,000

Less: Accounts uncollectible (9% of new sales)                       11,340

Annual incremental revenue                                                      114,660

Collection Costs                                                                                   15,900

Production and selling costs (70%*new sales)                        88,200

Income before taxes                                                                          10,560

Taxes (35%)                                                                                              3,696

Incremental income after taxes                                                                      6,864

a-2)

Accounts Receivable Turnover = Sales / Accounts Receivable

Accounts Receivable = Sales / Accounts Receivable Turnover

                                      = $126,000 / 4 = $31,500

Return on incremental investment = net income / accounts receivable

                                                                     = $6,864 / $31,500 = 21.79%

a-3)

Yes. Credit should be extended to these customers because the incremental return of 21.79% is greater than 10%.

b-1) Fast Turnstiles Co.

Added Sales                                                                                       $126,000

Less: Accounts uncollectible (12% of new sales)                     15,120

Annual incremental revenue                                                      110,880

Collection Costs                                                                                   15,900

Production and selling costs (70%*new sales)                        88,200

Income before taxes                                                                            6,780

Taxes (35%)                                                                                              2,373

Incremental income after taxes                                                                      4,407

b-2)

Accounts Receivable Turnover = Sales / Accounts Receivable

Accounts Receivable = Sales / Accounts Receivable Turnover

                                      = $126,000 / 4 = $31,500

Return on incremental investment = net income / accounts receivable

                                                                     = $4,407 / $31,500 = 13.99%

b-3)

Yes. Credit should be extended to these customers because the incremental return of 13.99% is greater than 10%.

c-1)

If receivable turnover drops to 2.0x then in that case the investment in accounts receivable would equal

    $126,000/2.0 = $63,000

Return on incremental investment = 6,864/63,000 = 10.90%

c-2)

Yes. Credit should not be extended because 10.9% is more than the desired 10%.

jeff jeffy answered 2 years ago
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