Chapter 3: 20BP_a (page 224)

Slow Roll Drum Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur $16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket. No other asset build-up will be required to service the new customers. The firm has a 10 percent desired return. Assume the average collection period is 120 days.
a. Compute the return on incremental investment.

Short Answer

Expert verified

The return on incremental investment is 7.92%.

Step by step solution

Information provided in the question

Increase in sales = $180,000

Production and marketing costs = 72%

Uncollectible accounts = 15%

Collection costs = $16,200

Income taxes = 34%

Accounts receivables turnover = 4 times

Calculation of incremental income after taxes

The incremental income after taxes is $4,752.

Particulars	Amount
Additional sales	$180,000
Accounts uncollectible (12% of additional sales)	($27,000)
Annual incremental revenue	$153,000
Collection costs	($16,200)
Production and marketing costs (72% of additional sales)	($129,600)
Annual income before taxes	$7,200
Taxes (34%)	($2,448)
Incremental income after taxes	$4,752

Calculation of accounts receivables

The accounts receivables is $60,000.

$\begin{array}{rcl} Accounts receivables & = & Average collection period \times Average daily sales \\ = & 120 \times \frac{$ 180, 000}{360} \\ = & 120 \times $ 500 \\ = & $ 60, 000 \end{array}$

Calculation of incremental after-tax return on investment

The incremental after-tax return on investment is 7.92%.

$\begin{array}{rcl} Incremental after - tax return on investment & = & \frac{Incremental income}{Investment in receivables} \times 100 \\ = & \frac{$ 4, 752}{$ 60, 000} \times 100 \\ = & 7.92 % \end{array}$

Unlock Step-by-Step Solutions & Ace Your Exams!

Full Textbook Solutions
Get detailed explanations and key concepts
Unlimited Al creation
Al flashcards, explanations, exams and more...
Ads-free access
To over 500 millions flashcards
Money-back guarantee
We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

Recommended explanations on Business Studies Textbooks

View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

January	\(8,500
February	\)2,500
March	\(3,500
April	\)8,500
May	\(9,500
June	\)4,500

January	9%
February	10%
March	13%
April	16%
May	12%
June	12%

Short Answer

Step by step solution

Information provided in the question

Calculation of incremental income after taxes

Calculation of accounts receivables

Calculation of incremental after-tax return on investment

One App. One Place for Learning.

Most popular questions from this chapter

Recommended explanations on Business Studies Textbooks

Organizational Behavior

Human Resources

Strategic Direction

Managers

Corporate Finance

Managerial Economics

Study anywhere. Anytime. Across all devices.