Tara\'s Textiles currently has credit sales of $361 million per year and an aver

Question

Tara's Textiles currently has credit sales of $361 million per year and an average collection period of 63 days. Assume that the price of Tara's products is $61 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable change that will result in a 20.4% increase in sales and a 19.5% increase in the average collection period. No change in bad debts is expected. The firm's equal-risk opportunity cost on its investment in accounts receivable is 13.2%. (Note: Use a 365-day year.)

a. Calculate the additional profit contribution from sales that the firm will realize if it makes the proposed change. (I calculated a. as $7,243,672)

b. What marginal investment in accounts receivable will result?

c. Calculate the cost of the marginal investment in accounts receivable.

d. Should the firm implement the proposed change? What other information would be helpful in your analysis?

Explanation / Answer

Answer a

Original Sales => 361 / 61=> 5918033 units

Increase in sales => 5918033 * 20.4% => 1207279 units

Additional profit contribution => (61 -55 ) * 1207279 => $7243674

Answer b

Turnover present plan => 361 / 63 => 5.73

Turnover proposed Plan => 361 / (63 + 19.5%) => 361 / 75 => 4.81

Average investment in Accounts receivable => Total variable cost of annual sales / Tornover of A/r

Average investment proposed Plan=> (5918033+ 20.4%)*55 / 4.81 => $81474458

Average investment present Plan => 5918033 * 55/ 5.73 => $56804854

Marginal investment in A/R => 81474458 - 56804584 => $24669604

Answwer c

Cost of marginal investment in accounts receivable => 24669604 * 13.2% => $3256388

Answer d

The additional profitability of $7243674 exceeds the additional costs of $3256388, therefore the proposed change should be adopted, yet one would need estimates of bad debt expenses, clerical costs, and some information about the uncertainty of the sales forecast prior to adoption of the policy.

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