Question

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 7 percent of the new accounts will be uncollectible. Collection costs are 5 percent of new sales, production and selling costs are 80 percent, and the accounts receivable turnover is four times. Assume income taxes of 30 percent and an increase in sales of $63,000. No other asset buildup will be required to service the new accounts.  

a. What additional investment in accounts receivable is needed to support this sales expansion?

	Incremental accounts receivable $15,750

   

b. What would be Henderson’s incremental aftertax return on investment? (Input your answer as a percent rounded to 2 decimal places.)
  

   

	Return on incremental investment %

c. Should Henderson liberalize credit if a 14 percent aftertax return on investment is required?
  

	Yes
	No

  

Assume that Henderson also needs to increase its level of inventory to support new sales and that the inventory turnover is four times.  

d. What would be the total incremental investment in accounts receivable and inventory needed to support a $63,000 increase in sales?
  

	Total incremental investment

   

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

	Yes
	No

Answer 1

a. Incremental accounts receivable : $ 15,750.

b. Return on incremental investment : 22.40 %

New Sales	$ 63,000
Bad Debts ( 7 % )	(4,410)
Collection Costs ( 5 % )	(3,150)
Production and Selling Costs ( 80% )	(50,400)
Income before Taxes	5,040
Income Taxes @ 30 %	1,512
Incremental Income After Taxes	3,528

Return on incremental investment = $ 3,528 / $ 15,750 * 100 = 22.40 %

c. Yes.

d. Total Incremental Investment : $ 31,500.

e. No.

Return on incremental investment = $ 3,528 / $ 31,500 * 100 = 11.20 %

As the return on incremental investment of 11.20 % is lower than the required return of 14 %, Henderson should not extend more liberal credit terms.