Johnson Electronics is considering extending trade credit to some customers prev

Question

Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $150,000 if credit is extended to these new customers. Of the new accounts recievable generated, 5% will prove to be uncollectible. Additional collection costs will be 2 percent of sales, and production and selling costs will be 74% of sales. The firm is in the 35% tax bracket.

a. Compute the incremental income after taxes.

b. what will Johnson's incremental return on sales be if these new credit customers are accepted?

c. If the receivable turnover ration is 3 to 1 and no other asset buildup is needed to serve the new customers, what will Johnson's incremental return on new average investment be?

Explanation / Answer

a. Compute the incremental income after taxes.

Solution-

b. what will Johnson's incremental return on sales be if these new credit customers are accepted?

Solution-

Incremental return on sales = Incremental income / Incremental Sales

Incremental return on sales = $18,525 / $150,000

Incremental return on sales = 0.1235 or 12.35%

c. If the receivable turnover ration is 3 to 1 and no other asset buildup is needed to serve the new customers, what will Johnson's incremental return on new average investment be?

Solution-

Receivable turnover = Sales / Receivable turnover = 6X

Receivables = Sales / Receivable turnover

Receivables = $150,000 / 6

Receivables = $25,000

Incremental return on new average investment = $18,525 / $25,000

Incremental return on new average investment = 0.741 or 74.10%

Additional sales $150,000 Less-Accounts uncollectible (5% of new sales) 7,500 Annual incremental revenue $142,500 Less-Collection costs (2% of new sales) 3,000 Less-Production and selling costs (74% of new sales) 111,000 Annual income before taxes $28,500 Taxes (35%) $9,975 Incremental income after taxes $18,525

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