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Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that...

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 6 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 80 percent, and the accounts receivable turnover is five times. Assume income taxes of 20 percent and an increase in sales of $74,000. 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 16 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 five times.  

D. What would be the total incremental investment in accounts receivable and inventory needed to support a $74,000 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?

please show work!

Solutions

Expert Solution

A. Investment in Accounts receivables = Increase in sales/Account receivables turnover = 74,000/ 5 = $14,800

B.

Amount
Increase in sales $74,000
Less-uncollectible accounts (6% of 74,000) $4,440
Less- collection costs (5% of 74,000) $3700
Less-production and selling costs (80% of 74,000) $59,200
Profit before taxes (Sales - all costs) $6,660
Less-tax (20% of 6,660) $1,332
Increment income after tax (profit before tax - tax) $5,328

Increment after tax return on investment = Increment income after tax/Investment in accounts receivables * 100

= 5,328/14,800 * 100 = 36%

C.Yes, Henderson should liberalize credit if a 16 percent after tax return on investment is required because existing return on investment of 36% is more than required return of 16%

D. Investment in inventory = Increased sales/inventory turnover = 74,000/5 = $14,800

Total investment investment in accounts receivables and inventory = 14,800 + 14,800 =$29,600

E. Return on investment = 5,328 (from part B)/ 29,600 (FROM PART D) * 100 = 18%

Yes, Henderson can liberalize credit terms because 18% is more than required return of 16%

jeff jeffy answered 1 year ago
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