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Chapter 3: 18BP_e (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.

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

Short Answer

Expert verified

The company should not liberalize its credit policy.

Step by step solution

01

Calculation of incremental after-tax return on investment

The incremental after-tax return on investment is 11.74%.

Incrementalafter-taxreturnoninvestment=IncrementalincomeTotalincrementalinvestment×100=$5,720$48,750×100=11.74%

02

Credit policy should not be liberalized

The required rate of incremental return is 16% but the company has an incremental after-tax return on investment of 11.74%, so the company should not liberalize its credit policy. The liberalization of the credit policy can result in an increase in the risk of bad debts and a decrease in cash inflows.

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Most popular questions from this chapter

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Antivirus Inc. expects its sales next year to be \(2,500,000. Inventory and accounts receivable will increase \)480,000 to accommodate this sales level. The company has a steady profit margin of 15 percent with a 35 percent dividend payout. How much external financing will the firm have to seek? Assume there is no increase in liabilities other than that which will occur with the external financing

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.

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