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 $630,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows: Accounts receivable 5x Inventory 4x Plant and equipment 3x All $630,000 of the sales will be collectible. However, collection costs will be 4 percent of sales, and production and selling costs will be 74 percent of sales. The cost to carry inventory will be 8 percent of inventory. Depreciation expense on plant and equipment will be 20 percent of plant and equipment. The tax rate is 25 percent. (a) What is the value for inventory investment? (Omit the "$" sign in your response.) Inventory investment $ (b-1) Compute the total investment. (Omit the "$" sign in your response.) Total investment $ (b-2) Compute the cost of carrying inventory. (Omit the "$" sign in your response.) Cost of carrying inventory $ (b-3) Compute income after taxes. (Omit the "$" sign in your response.) Income after taxes $ (b-4) What would be the return on investment? (Round your answer to 2 decimal places. Omit the "%" sign in your response.) Return on investment % (b-5) If the required rate of return is 14 percent, should the campaign be undertaken? No Yes

Explanation / Answer

Investment required in accounts receivable=Increase in sales/Accounts receivable turnover = $630,000 / 5

=$126,000

Investment required in inventory = $630,000 / 4

= $157,500

Investment required in Plant and Equipment

= $630,000/3

= $210,000

Total investment required = $126,000 + $157,500 + $210,000

= $493,500

b. compute the accounts receivable collection costs and production and selling costs and add the two figures together.

Accounts receivable collection costs = $630,000*4%

= $25,200

Production and selling costs = $630,000*74%

= $466,200

Total collection and production costs = $491,400

c. Compute the cost of carrying inventory.

Cost of carrying inventory =8% of investment in inventory
                                    

= $157,500*8%

=$12,600

d. Compute the depreciation expense on the new plant & equipment.

Depreciation expanses = 20% of investment in Plant and equipment

= 20%* $210,000

= $42,000

e. add together all the costs in parts, b, c, d.

Total costs = $491,400 + $12,600 + $42,000

=$546,000

f. Subtract the answer from part e from the sales figure of 630,000 to arrive at income before taxes. Subtract taxes at the rate of 20% to arrive at income after taxes.

Income before taxes = $630,000 - $546,000

= $84,000

Income after taxes = $84,000*(1-25%)

= $63,000

g. divide the aftertax return figure in part f by the total investment in part a. If the firm has a required return on investment of 14%, should it undertake the promotional campaign described throughout this problem.

Rate of return = $63,000 / $493,500

= 12.76%

Since the Rate of return is more than required rate of return, the company should take promotional campaign

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