Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers....

Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $144,000 in additional credit sales, 10 percent are likely to be uncollectible. The company will also incur $16,000 in additional collection expense. Production and marketing costs represent 71 percent of sales. The firm is in a 35 percent tax bracket. No other asset buildup will be required to service the new customers. The firm has a desired return of 12 percent. Assume the average collection period is 72 days.

a. Compute the return on incremental investment. (Input your answer as a percent rounded to 2 decimal places. Use a 360-day year.)

Return on incremental investment _______________ %

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Expert Solution

Increase in sales	$144,000
Accounts uncollectible (10%*144000)	$14,400
Annual incremental revenue	$129,600
Collection costs	$16,000
Production and selling costs (71%*144000)	$102,240
Annual income before taxes	$11,360
Income tax @ 35%	$3,976
Incremental income after taxes	$7,384

We have calculated the incremental income after taxes by reducing incremental costs from incremental revenue.
Now we will have to calculate the incremental investment amount in this case which is accounts receivable.

The average collection period is 72 days
Therefore, the investment in accounts receivable would be	144000*(72/360)
Therefore, the investment in accounts receivable would be	28800

Incremental return on investment	7384/28800
Incremental return on investment	25.64%

Return on incremental investment is 25.64%

Since the incremental return is more than the desired return, company should provide sales at credit.

jeff jeffy answered 1 year ago

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