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Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $125,000 if credit were extended to these new customers. Of the new accounts receivable generated, 8% will prove to be uncollectible. Additional collection costs will be 3% of sales, and production and selling costs will be 80% of sales. The firm is in the 30 percent tax bracket.
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 6 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?

Answer :

JEPESSOAGO

Answer:

net increase in sales = $125,000 x (1 - 8% - 3%) = $111,250

net increase in costs = $125,000 x 80% = $100,000

average investment in assets = $125,000 / 6 = $20,833

A. Compute the incremental income after taxes.

  • incremental income = $111,250 - $100,000 = $11,250

B. What will Johnson’s incremental return on sales be if these new credit customers are accepted?

  • return on sales = $11,250 / $125,000 = 9%

C. If the accounts receivable turnover ratio is 6 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?

  • = $11,250 / $20,833 = 54%

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