Investment and Percent After-tax Return

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Credit Policy Decisions
Christian L. Proulx
Axia College of University of Phoenix
Credit Policy Decisions

Collins Office Supplies is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 78 percent, and accounts receivable turnover is five times. Assume income taxes of 30 percent and an increase in sales of $80,000. No other asset buildup will be required to service the new accounts.

a. What is the level of accounts receivable needed to support this sales expansion?
Answer- Level needed is [pic]

b. What would be Collins’s incremental after-tax return on investment?
80,000 – 7,200 = 72,800-4,000-62,400=6,450-1,920= $4,480 which is equal to 28 percent.

c. Should Collins liberalize credit if a 15 percent after-tax return on investment is required? Assume Collins also needs to increase its level of inventory to support new sales and that inventory turnover is four times.

Yes, the actual return was higher than the requirement.

d. What would be the total incremental investment in accounts receivable and inventory to support an $80,000 increase in sales?
Inventory 20,000+Accounts 16,000 = 36,000 which would be a 12.44 percent return.

e. Given the income determined in part b and the investment determined in part d, should Collins extend more liberal credit terms?
Absolutely not, 12.44 percent is less than 15 percent which is the required mark.
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