Boswell’s Greenhouse is considering a promotional campaign, if successful, that would increase annual credit sales by...

Boswell’s Greenhouse is considering a promotional campaign, if successful, that would increase annual credit sales by $700,000. To accomplish that, Boswell will have to invest in accounts receivable, inventory, and plant and equipment. The turnover in each of those areas is 6x, 6x, and 2x, respectively. All $700,000 in additional sales will be collectible—but at an expense of 3% of sales. Production and selling costs will be 75% of sales. The cost to carry inventory will be 5% of inventory. Depreciation expense will be 5% of plant and equipment. The tax rate is 25%. Find: (1) total investment in accounts receivable, inventory, and plant and equipment based on the turnover ratios, then add the three figures together; (2) compute accounts receivable collection costs and production and selling costs and add them together; (3) compute the costs of carrying inventory; (4) compute the depreciation expense on the plant and equipment; (5) add all the costs in (2), (3), and (4) together; (6) Subtract the answer in (5) from the sales figure of $700,000 to arrive at income before taxes. Subtract taxes at 25% to arrive at income after taxes; (7) divided after tax income by the total investment in (1). Should the firm undertake the promotional campaign described here if the required rate of return is 12%? Explain your answer.

Expert Solution

Let us create a cost of sales sheet with the given data

PARTICULARS	AMOUNT
Sales total	700,000
Less: Production and selling costs	= 700,000 * 75% = 525,000
Total profit before tax	= 175,000
Less: Cost to carry inventory	= 6x * 5% = 0.30x
Less: Depreciation	= 2x * 5% = 0.10x
Less: Sales collection costs	= 700,000 * 3% = 21,000
Net Profit before taxes	= 700,000 - 0.30x - 0.10x -21000 = 175,000 = 679,000 - 0.40x = 175,000 = x = 1,260,000

1. Therefore, Turnover = 6*1.26 million = $ 7.56 million; as well as inventory = 6x = $ 7.56 million ; Plant and Equipment = 2x = 2 * 1.26 = $ 2.52 million; Total = 7.56 + 7.56 + 2.52 = $ 17.68 million

2. Accounts receivable collection costs = 3% of 7.56 million = $ 226,800 ; Production and selling costs = 700000 * 75% = 525,000. Total = 226800 + 525000 = $ 751,800

3. Cost of carrying inventory = 0.30x = 1,260,000 * 0.30 = $ 378,000.

4. Depreciation = 0.10x = 1260,000 * 0.10 = $ 126,000

5. Total costs = 751800 + 378000 + 126000 = 1,255,800

6. Total loss = 1255800 - 700000 = -555,800

7. Since the following is leading to a negative cash flow, it can be concluded that the firm should not undertake such a promotional campaign.

jeff jeffy answered 2 years ago

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