Proposal #1 would extend trade credit to some customers that previously have been denied credit because they were considered poor risks. Sales are projected to increase by $200,000 per year if credit is extended to these new customers. Of the new accounts receivable generated, 7% are projected to be uncollectible. Additional collection costs are projected to be 3% of incremental sales (whether they actually end up collected or not), and production and selling costs are projected to be 80% of sales. Your firm expects to pay a total of 30% of its income after expenses in taxes.
Compute the incremental income after taxes that would result from these projections:
Compute the incremental Return on Sales if these new credit customers are accepted If the receivable turnover ratio is expected to be 4 to 1 and no other asset buildup is needed to serve the new customers…
Compute the additional investment in Accounts Receivable
Compute the incremental Return on New Investment
If your company requires a 20% Rate of Return on Investment for all proposals, do the numbers suggest that trade credit should be extended to these new customers? Explain.