Tanner Co. is a highly successful supplier of leather to manufacturers of leathe

Question

Tanner Co. is a highly successful supplier of leather to manufacturers of leather goods. Tanner is considering expanding into the U.S. luxury auto seat market. It is estimated that although selling leather to U.S. auto manufacturers will bring additional annual sales of $720,000, a high 10% of those accounts will be uncollectible. The cost of conditioning and selling the leather is 65% of sales. Tanner's tax rate is 40%.

a) Calculate Tanner's incremental net income on the new sales.

b) Assume Tanner has a receivables turnover of 4. Calculate Tanner's incremental accounts receivable investment and after-tax return on that investment.

c) Tanner's minimum required ROI is 18%. Should Tanner expand into the auto market?

Explanation / Answer

Tanner Co Details Amt $ Additional Annual Sales                         720,000 Less: Cost of Conditioning & Selling@65%                       468,000 Less: Bad debt Expense@10%                         72,000 Net Income before Tax                       180,000 Tax @40%                         72,000 Net Income After Tax                         108,000 a So Incremental net Income on new sales =                       108,000 b Tanners Receivable turnover =4 Annual Receivable =720000-72000=                       648,000 Average Accounts Receivable =648000/4=                       162,000 So Tanners' Investment in Accounts Receivable=                       162,000 Net Inocome for the US sales =                       108,000 Tanners' Investment in Accounts Receivable=                       162,000 After Tax return on the investment =108000/162000= 66.67% c Tanners required ROI is 18% As the after Tax return on the Investment in   Accounts receivable is 66.67% (more than ROI), Tanners' should enter the US Auto Market.

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