Archer Chemical is thinking about extending trade credit to new customers. Sales would increase by $80,000 if credit were extended to these customers. Of the new accounts receivable related to these sales, 8 percent would be uncollectible. Additional collection costs would be 4 percent of sales, an

Question

Archer Chemical is thinking about extending trade credit to new customers. Sales would increase by [latex]\$ 80,000[/latex] if credit were extended to these customers. Of the new accounts receivable related to these sales, 8 percent would be uncollectible. Additional collection costs would be 4 percent of sales, and selling and collection costs would be 80 percent of sales. The firm is in a 30 percent tax bracket.

a. Compute the new income after taxes.

b. What will be the percentage return on the new sales?

c. If accounts receivable are turned over four times a year, what will be the new investment in accounts receivable?

d. What will be the return on investment assuming the only new investment will be in accounts receivable?

Accepted Answer

a.

Additional sales	$80,000
Accounts uncollectible (8% of new sales)	6,400
Annual incremental revenue	$73,600
Collection costs (4% of new sales)	3,200
Production and selling costs (80% of new sales)	64,000
Annual income before taxes	6,400
Taxes (30%)	1,920
Annual incremental income after taxes	$ 4,480

b. [latex]\quad \frac{ ext { Incremental income }}{ ext { Sales }}=\frac{\$ 4,480}{80,000}=5.6 \%[/latex]

c. [latex]\quad[/latex] Accounts receivable [latex]=\frac{ ext { Sales }}{ ext { Accounts receivable turnover }}[/latex]

[latex]=\frac{\$ 80,000}{4}=\$ 20,000[/latex]

d. [latex]\quad[/latex] Return on investment [latex]=\frac{ ext { Incremental income }}{ ext { Accounts receivable }}=\frac{\$ 4,480}{20,000}=22.40 \%[/latex]

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