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 $150,000 per year if credit is extended to these new customers. Of the new accounts receivable generated, 9% 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 77% of sales. Your firm expects to pay a total of 40% of its income after expenses in taxes.
1) Compute the incremental income after taxes that would result from these projections:
2) Compute the incremental Return on Sales if these new credit customers are accepted:
If the receivable turnover ratio is expected to be 2.5 to 1 and no other asset buildup is needed to serve the new customers…
3) Compute the additional investment in Accounts Receivable
4) Compute the incremental Return on New Investment
5) If your company requires a 18% Rate of Return on Investment for all proposals, do the numbers suggest that trade credit should be extended to these new customers? Explain.