Tara\'s Textiles currently has credit sales of $363 million per year and an aver

ID: 2740578 • Letter: T

Question

Tara's Textiles currently has credit sales of $363 million per year and an average collection period of 65 days. Assume that the price of Tara's products is $61 per unit and that the variable costs are $54 per unit. The firm is considering an accounts receivable change that will result in a 20.8% increase in sales and a 19.8% 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 14.6%. (Note: use a 365-day year).

a. Calculate the additional profit contribution from new sales that the firm will realize if it makes the proposed change 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

Calculate the additional profit contribution from new sales that the firm will realize if it makes the proposed change:

Details

Amount

Credit sales

$363 million

Add: Changes in sales
($363 million * 20.8%)

$75.504 million

Total

$438.504 million

Number of units changes in sales
($75.504 million /$61)

1,277,770.49

Contribution per unit ($61 - $54) $7

$ 8,944,393.43

Therefore, increase the contribution margin $8,944,393.43.

Calculate the marginal investment in accounts receivable will result:

Average collection period is 65 days

Increase in the collection period = (65 days) + (65 days *19.8%) = 77.87 days

Margin investment in accounts receivable = $438.504 million * 77.87 days/365 days = $93.55 million

= $75.504 million sales increased

Calculate the cost of the marginal investment in accounts receivable:

Cost of the marginal investment = $75.504 million * 14.60% = $11.024 million

Cost of marginal investment is higher than the profit of changes in accounts receivable. The proposal of company not implemented.