Question

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 10 percent of the new accounts will be uncollectible. Collection costs are 2 percent of new sales, production and selling costs are 75 percent, and the accounts receivable turnover is three times. Assume income taxes of 30 percent and an increase in sales of $66,000. No other asset buildup will be required to service the new accounts.

a. What additional investment in accounts receivable is needed to support this sales expansion?

b. What would be Henderson’s incremental aftertax return on investment? (Input your answer as a percent rounded to 2 decimal places.)

c. Should Henderson liberalize credit if a 17 percent aftertax return on investment is required? Yes OR No

Assume that Henderson also needs to increase its level of inventory to support new sales and that the inventory turnover is four times.

d. What would be the total incremental investment in accounts receivable and inventory needed to support a $66,000 increase in sales?

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms? Yes OR No

Answer 1

a	Investments in Accounts Receivables
	66000/3		22,000
b	Incremental after Tax Return
	Sales		66,000
	Uncollectible Accounts Rec 10% of sales		6,600
	Incremental revenue		59,400
	Collection cost 2% of sales		1,320
	Production and selling cost 75% of sales		49,500
	Income before tax		8,580
	Tax 30% of income before tax		2,574
	Income after tax		6,006
	Return on increased investment		6006/22000
			27.30%
c	Yes as 27.30 is more than 17%
d	Incremental investment in inventory		66000/4
			16,500
	Incremental investment in AR		22,000
	Total Investments		38,500
	% return		6006/38500
			15.60%
e	No, as 15.60% is less than 17% required rate of return