Henderson Office Supplies is considering a more liberal credit policy to increase sales, but it expects that 8 percent of the new accounts will be uncollectible.
Collection costs are 5 percent of new sales, production costs are 78 percent of sales, and accounts receivable turnover is five times. Assume an increase in sales of $60,000. No other asset buildup will be required to service the new accounts.
a. What is the level of investment in accounts receivable to support this sales expansion?
b. What would be Henderson's incremental before-tax return on investment?
c. Should Henderson liberalize credit if a 25 percent before tax return is required (opportunity cost of capital)? Assume Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is four times.
d. What would be the total incremental investment in accounts receivable and inventory to support a $60,000 increase in sales?
e. Given the income determined in part band the investment determined in part d, should Henderson extend more liberal credit terms?