Fast Turnstiles Co. is evaluating the extension of credit to a new group of cust
ID: 2616259 • Letter: F
Question
Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide $126,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $15,900 in additional collection expense. Production and marketing costs represent 70 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 10 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) Fast Turnstiles Co.
Added Sales $126,000
Less: Accounts uncollectible (9% of new sales) 11,340
Annual incremental revenue 114,660
Collection Costs 15,900
Production and selling costs (70%*new sales) 88,200
Income before taxes 10,560
Taxes (35%) 3,696
Incremental income after taxes 6,864
a-2)
Accounts Receivable Turnover = Sales / Accounts Receivable
Accounts Receivable = Sales / Accounts Receivable Turnover
= $126,000 / 4 = $31,500
Return on incremental investment = net income / accounts receivable
= $6,864 / $31,500 = 21.79%
a-3)
Yes. Credit should be extended to these customers because the incremental return of 21.79% is greater than 10%.
b-1) Fast Turnstiles Co.
Added Sales $126,000
Less: Accounts uncollectible (12% of new sales) 15,120
Annual incremental revenue 110,880
Collection Costs 15,900
Production and selling costs (70%*new sales) 88,200
Income before taxes 6,780
Taxes (35%) 2,373
Incremental income after taxes 4,407
b-2)
Accounts Receivable Turnover = Sales / Accounts Receivable
Accounts Receivable = Sales / Accounts Receivable Turnover
= $126,000 / 4 = $31,500
Return on incremental investment = net income / accounts receivable
= $4,407 / $31,500 = 13.99%
b-3)
Yes. Credit should be extended to these customers because the incremental return of 13.99% is greater than 10%.
c-1)
If receivable turnover drops to 2.0x then in that case the investment in accounts receivable would equal
$126,000/2.0 = $63,000
Return on incremental investment = 6,864/63,000 = 10.90%
c-2)
Yes. Credit should not be extended because 10.9% is more than the desired 10%.
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