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Chapter 3: 18BP_b (page 223)

Henderson Office Supply 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 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

b. What would be Henderson’s incremental after-tax return on investment?

Short Answer

Expert verified

The incremental after-tax return on investment is 35.2%.

Step by step solution

01

Information provided in the question

Increase in sales = $65,000

Production and selling costs = 74%

Uncollectible accounts = 9%

Collection costs = 6%

Income taxes = 20%

Accounts receivables turnover = 4 times

02

Calculation of incremental income after taxes

The incremental income after taxes is $5,720.

Particulars

Amount

Additional sales

$65,000

Accounts uncollectible (9% of additional sales)

($5,850)

Annual incremental revenue

$59,150

Collection costs (6% of additional sales)

($3,900)

Production and selling costs (74% of additional sales)

($48,100)

Annual income before taxes

$7,150

Taxes (20%)

($1,430)

Incremental income after taxes

$5,720

03

Calculation of incremental after-tax return on investment

The incremental after-tax return on investment is 35.2%.

Incrementalafter-taxreturnoninvestment=IncrementalincomeInvestmentinreceivables×100=$5,720$16,250×100=35.2%

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Most popular questions from this chapter

Neon Light Company of Kansas City ships lamps and lighting appliances throughout the country. Ms. Neon has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by three days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Florida.

b. If Neon Light Company can earn 6 percent per annum on freed-up funds, how much will the income be?

Henderson Office Supply 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 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?

Explain how rapidly expanding sales can drain the cash resources of a firm.

Discuss the relative volatility of short- and long-term interest rates

How is a cash budget used to help manage current assets?
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