Joni Services is considering a promotional campaign that will increase annual cr
ID: 2700696 • Letter: J
Question
Joni
Services is considering a promotional campaign that will increase annual credit sales by $610,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:
All $610,000 of the sales will be collectible. However, collection costs will be 2 percent of sales, and production and selling costs will be 70 percent of sales. The cost to carry inventory will be 10 percent of inventory. Depreciation expense on plant and equipment will be 10 percent of plant and equipment. The tax rate is 30 percent.
Compute the investments in accounts receivable, inventory, and plant and equipment based on the turnover ratios. Add the three together. (Omit the "$" sign in your response.)
Compute the accounts receivable collection costs and production and selling costs and add the two figures together. (Omit the "$" sign in your response.)
Compute the costs of carrying inventory. (Omit the "$" sign in your response.)
Compute the depreciation expense on new plant and equipment. (Omit the "$" sign in your response.)
Services is considering a promotional campaign that will increase annual credit sales by $610,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:
Explanation / Answer
Investment required in accounts receivable=Increase in sales/Accounts receivable turnover = $400,000 / 4
=$100,000
Investment required in inventory = $400,000 / 8
= $50,000
Investment required in Plant and Equipment
= $400,000/2
= $200,000
Total investment required = $100,000 + $50,000 + $200,000
= $350,000
b. compute the accounts receivable collection costs and production and selling costs and add the two figures together.
Accounts receivable collection costs = $400,000*4%
= $16,000
Production and selling costs = $400,000*76%
= $304,000
Total collection and production costs = $320,000
c. Compute the cost of carrying inventory.
Cost of carrying inventory =8% of investment in inventory
= $50,000*8%
=$4,000
d. Compute the depreciation expense on the new plant & equipment.
Depreciation expanses = 5% of investment in Plant and equipment
= 5%* $200,000
= $10,000
e. add together all the costs in parts, b, c, d.
Total costs = $320,000 + $4,000 + $10,000
=$334,000
f. Subtract the answer from part e from the sales figure of 400,000 to arrive at income before taxes. Subtract taxes at the rate of 30% to arrive at income after taxes.
Income before taxes = $400,000 - $334,000
= $66,000
Income after taxes = $66,000*(1-30%)
= $46,200
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 12%, should it undertake the promotional campaign described throughout this problem.
Rate of return = $46,200 / $350,000
= 13.20%
Since the Rate of return is more than required rate of return, the company should take promotional campaign
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