Fast Turnstiles Co. is evaluating the extension of credit to a new group of cust

Question

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $270,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $16,700 in additional collection expense. Production and marketing costs represent 75 percent of sales. The firm is in a 35 percent tax bracket and has a receivables turnover of four times. No other asset buildup will be required to service the new customers. The firm has a 8 percent desired return.  

a-1. Calculate the incremental income after taxes.  
  

    

a-2. Calculate the return on incremental investment. (Input your answer as a percent rounded to 2 decimal places.)
  

   

a-3. Should Fast Turnstiles Co. extend credit to these customers?
  

  

b-1. Calculate the incremental income after taxes if 12 percent of the new sales prove to be uncollectible.
  

   

b-2. Calculate the return on incremental investment if 12 percent of the new sales prove to be uncollectible. (Input your answer as a percent rounded to 2 decimal places.)
  

     

b-3. Should credit be extended if 12 percent of the new sales prove uncollectible?
  

  

c-1. Calculate the return on incremental investment if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible. (Input your answer as a percent rounded to 2 decimal places.)
  

   

c-2. Should credit be extended if the receivables turnover drops to 2.0, and 9 percent of the accounts are uncollectible?
  

Explanation / Answer

a-1 Incremental Income after taxes Additional Credit Sales $270,000 Less : Uncollectible (9%*270000) 24300 Collection Expense 16700 Production and marketing costs (75% of 270000) 202500 Income before tax $26,500 Tax @ 35% $9,275 Incremental income after tax $17,225 a-2 Return on incremental investment Receivables turnover - 4 times Credit Sales/Accounts receivable Accounts receivable = 270000/4 67500 Return on Investment 17225/67500 25.52% a-3 Yes, Fast Turnstiles Co should extend credit to these customers as return on investment is more than the required return b-1 Additional Credit Sales $270,000 Less : Uncollectible (12%*270000) 32400 Collection Expense 16700 Production and marketing costs (75% of 270000) 202500 Income before tax $18,400 Tax @ 35% $6,440 Incremental income after tax $11,960 b-2 Return on investment 11960/67500 17.72% b-3 Yes, Fast Turnstiles Co should extend credit to these customers as return on investment is more than the required return c-1 Receivables turnover - 2 times Credit Sales/Accounts receivable Accounts receivable = 270000/2 135000 Return on investment 17225/135000 12.76% c-2 Yes, Fast Turnstiles Co should extend credit to these customers as return on investment is more than the required return

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