Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $115,000 if credit were extended to these new customers. Of the new accounts receivable generated, 9 percent will prove to be uncollectible. Additional collection costs will be 6 percent of sales, and production and selling costs will be 75 percent of sales. The firm is in the 30 percent tax bracket. Required:
a. Compute the incremental income after taxes.
b. What will Johnson’s incremental return on sales be if these new credit customers are accepted?
c. If the accounts receivable turnover ratio is 3 to 1, and no other asset buildup is needed to serve the new customers, what will Johnson’s incremental return on new average investment be?

See answers below

Explanation:

Incremental income after tax

Incremental sales. $115,000

Less:

Expected uncollectibles

(115,000 × 9%) $10,350

Additional collection cost

(115,000 × 6%) $6,900

Production and selling cost

(115,000 × 75%) $86,250

Total balance. ($103,500)

Increase in before- tax inc. $11,500

Less: tax 30%. ($3,450)

Increase in after tax income $8,050

a. Incremental income after taxes $8,050

b. Johnson's incremental return on sales

= Increase in after - tax income / incremental sales

= $8,050 / $115,000

= 7%

c. Incremental return on new average

Incremental sales. $115,000

Accounts receivable

turnover ratio. 3

Average investments.

in assets $38,333

*Note: Average investment in assets = Sales / Accounts receivable turnover ratio.

Incremental return on new average investment

= Increase in after tax income / Average investments in assets

= $8,050 / $38,333

= 21%

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