Question

Global Services is considering a promotional campaign that will increase annual credit sales by $540,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:  
  

Accounts receivable	4	times
Inventory	8	times
Plant and equipment	2	times

     
All $540,000 of the sales will be collectible. However, collection costs will be 5 percent of sales, and production and selling costs will be 74 percent of sales. The cost to carry inventory will be 4 percent of inventory. Depreciation expense on plant and equipment will be 15 percent of plant and equipment. The tax rate is 25 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 then add the two figures together.
  

   

c. Compute the costs of carrying inventory.
  

   

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

     

e. Compute the total of all costs from parts b through d.
  

   

f. Compute income after taxes.
  

   

g-1. What is the aftertax rate of return? (Input your answer as a percent rounded to 2 decimal places.)
  

    

g-2. If the firm has a required return on investment of 10 percent, should it undertake the promotional campaign described throughout this problem?
  

	Yes
	No

Answer 1

Answer to Part a.

Accounts Receivable = Sales / Accounts Receivable Turnover
Accounts Receivable = 540,000 / 4
Accounts Receivable = $135,000

Inventory = Sales / Inventory Turnover
Inventory = 540,000 / 8
Inventory = $67,500

Plant and Equipment = Sales / Plant and Equipment Turnover
Plant and Equipment = 540,000 / 2
Plant and Equipment = $270,000

Total Investment = Accounts Receivable + Inventory + Plant and Equipment
Total Investment = $135,000 + $67,500 + $270,000
Total Investment = $472,500

Answer to Part b.

Accounts Receivable Collection Costs = 5% of Sales
Accounts Receivable Collection Costs = 5% of $540,000 = $27,000

Production and Selling Costs = 74% of Sales
Production and Selling Costs = 74% of $540,000 = $399,600

Total Collection, Production and Selling Costs = $27,000 + $399,600
Total Collection, Production and Selling Costs = $426,600

Answer to Part c.

Cost of carrying Inventory = 4% of Inventory
Cost of carrying Inventory = 4% of $67,500
Cost of carrying Inventory = $2,700

Answer to Part d.

Depreciation Expense = 15% of Plant and Equipment
Depreciation Expense = 15% of $270,000
Depreciation Expense = $40,500

Answer to Part e.

Total of All Costs = $426,600 + $2,700 + $40,500
Total of All Costs = $469,800