Global Services is considering a promotional campaign that will increase annual

Question

Global Services is considering a promotional campaign that will increase annual credit sales by $620,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows: Accounts receivable 4x Inventory 8x Plant and equipment 2x All $620,000 of the sales will be collectible. However, collection costs will be 3 percent of sales, and production and selling costs will be 73 percent of sales. The cost to carry inventory will be 4 percent of inventory. Depreciation expense on plant and equipment will be 15 percent of plant and equipment. The tax rate is 35 percent. (a) Compute the investments in accounts receivable, inventory, and plant and equipment based on the turnover ratios. Add the three together. (Omit the "$" sign in your response.) Accounts receivable $ Inventory Plant and equipment Total Investment $ (b) Compute the accounts receivable collection costs and production and selling costs and add the two figures together. (Omit the "$" sign in your response.) Collection cost $ Production and selling costs Total costs related to accounts receivable $ (c) Compute the costs of carrying inventory. (Omit the "$" sign in your response.) Cost of carrying inventory $ (d) Compute the depreciation expense on new plant and equipment. (Omit the "$" sign in your response.) Depreciation expense $ (e) Compute total cost. (Omit the "$" sign in your response.) Total costs $ (f) Compute income after taxes. (Omit the "$" sign in your response.) Income after taxes $ (g) If the firm has a required return on investment of 12 percent, should it undertake the promotional campaign described throughout this problem? Yes No

Explanation / Answer

a) Investment required in accounts receivable=Increase in sales/Accounts receivable turnover = $620,000 / 4 =$155,000 Investment required in inventory = $620,000/ 8= $77,500 Investment required in Plant and Equipment = $620,000/2= $310,000 Total investment required = $155,000 + $77,500+ $310,000 = $542,500 b. Accounts receivable collection costs = $620,000*3% = $18600 Production and selling costs = $620,000*73% = $452,600 Total collection and production costs = $471200

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