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Chapter 07: Current Asset Management
7-20. Solution:
Slow Roll Drum Co.
a. Added sales........................................................... $180,000
Accounts uncollectible (12% of new sales)............ 21,600
First compute the accounts receivable balance.
Accounts receivable = average collection × average daily
period sales
$180,000
120 days 120 $500 $60,000
360 days
´ = ´ =
Then, compute return on incremental investment.
$8,316 13.86%
$60, 000 =
Yes, extend credit. 13.86 percent is greater than 10 percent.
21. Credit policy and return on investment (LO4) Global Services is considering a
promotional campaign that will increase annual credit sales by $450,000. The company
will require investments in accounts receivable, inventory, and plant and equipment. The
turnover for each is as follows:
Accounts receivable.................................... 2x
Inventory..................................................... 6x
Plant and equipment.................................... 1x
All $450,000 of the sales will be collectible. However, collection costs will be 6 percent of
sales, and production and selling costs will be 71 percent of sales. The cost to carry
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of McGraw-Hill Education.
Chapter 07: Current Asset Management
inventory will be 4 percent of inventory. Depreciation expense on plant and equipment will
be 5 percent of plant and equipment. The tax rate is 30 percent.
a. Compute the investments in accounts receivable, inventory, and plant and equipment
based on the turnover ratios. Add the three together.
b. Compute the accounts receivable collection costs and production and selling costs
and then add the two figures together.
c. Compute the costs of carrying inventory.
d. Compute the depreciation expense on new plant and equipment.
e. Add together all the costs in parts b, c, and d.
f. Subtract the answer from part e from the sales figure of $450,000 to arrive at income
before taxes. Subtract taxes at a rate of 30 percent to arrive at income after taxes.
g. Divide the aftertax return figure in part f by the total investment figure in part a. If the
firm has a required return on investment of 8 percent, should it undertake the
promotional campaign described throughout this problem.
7-21. Solution:
Global Services
a. Accounts receivable = Sales/Accounts receivable turnover
$225,000 $450,000/2=
Inventory = Sales/Inventory turnover
$75,000 $450,000/6=
Plant and equipment = Sales/(Plant and equipment turnover)
$450,000 450, 000 1
$ /
=
7-21. (Continued)
b. Collection cost = 6% × $450,000 $ 27,000
c. Cost of carrying inventory
4% × inventory
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of McGraw-Hill Education.
Chapter 07: Current Asset Management
d. Depreciation expense
e. Total costs related to accounts receivable $346,500
f. Sales $450,000
– Total costs 372,000
g.
Income after taxes $54, 600 7.28%
Total investment 750, 000
= =
(Problems 22–25 are a series and should be completed in order.)
22. Credit policy decision with changing variables (LO4) Dome Metals has credit sales of
$180,000 yearly with credit terms of net 60 days, which is also the average collection
period. Dome does not offer a discount for early payment, so its customers take the full 60
days to pay. What is the average receivables balance? Receivables turnover?
7-22. Solution:
Dome Metals
Sales/360 days = Average daily sales
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of McGraw-Hill Education.
Chapter 07: Current Asset Management
Receivable turnover =
Sales $180,000 6
Receivables $30,000
= =
or
23. Dome Metals had credit sales of $180,000 yearly. Dome offered a 3 percent discount for
payment in 18 days. What would the average receivables balance be?
7-23. Solution:
24. Dome Metals had credit sales of $180,000 yearly with credit terms of net 60 days, which is
also the average collection period. If Dome offered a 3 percent discount for payment in 18
7-24. Solution:
Sales / 360 days = Average daily sales
$180,000 / 360 = $500
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 07: Current Asset Management
25. Dome Metals has credit sales of $180,000 yearly with credit terms of net 60 days, which is
also the average collection period. Dome offered a 3 percent discount for payment in 18
days, and Dome reduced its bank loans, which cost 12 percent. Assume that the new trade
terms of 3/18, net 60 will increase sales by 15 percent because the discount makes the
Dome’s price competitive. If Dome earns 20 percent on sales before discounts, what will be
the net change in income? Should it offer the discount?
7-25. Solution:
New sales = $180,000 × 1.15 = $207,000
Change in sales = $207,000 – $180,000 = $ 27,000
Sales per day = $207,000/360 = $575
COMPREHENSIVE PROBLEM
Logan Distributing Company (receivables and inventory policy) (LO4 and 5) Logan
Distributing Company of Atlanta sells fans and heaters to retail outlets throughout the Southeast.
Joe Logan, the president of the company, is thinking about changing the firm’s credit policy to
attract customers away from competitors. The present policy calls for a 1/10, net 30 cash
discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of
Logan customers are taking the discount, and it is anticipated that this number would go up to 50
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Chapter 07: Current Asset Management
percent with the new discount policy. It is further anticipated that annual sales would increase
from a level of $400,000 to $600,000 as a result of the change in the cash discount policy.
The increased sales would also affect the inventory level. The average inventory carried by
Logan is based on a determination of an EOQ. Assume sales of fans and heaters increase from
15,000 to 22,500 units. The ordering cost for each order is $200 and the carrying cost per unit is
$1.50 (these values will not change with the discount). The average inventory is based on
EOQ/2. Each unit in inventory has an average cost of $12.
Cost of goods sold is equal to 65 percent of net sales; general and administrative expenses are
15 percent of net sales, and interest payments of 14 percent will only be necessary for the
increase in the accounts receivable and inventory balances. Taxes will be 40 percent of
before-tax income.
a. Compute the accounts receivable balance before and after the change in the cash
discount policy. Use the net sales (total sales minus cash discounts) to determine the
average daily sales.
b. Determine EOQ before and after the change in the cash discount policy. Translate this
into average inventory (in units and dollars) before and after the change in the cash
discount policy.
c. Complete the following income statement.
Before Policy
Change
After Policy
Change
Net sales (Sales – Cash discounts)................
Cost of goods sold.........................................
Gross profit...................................................
General and administrative expense.............
Operating profit.............................................
Interest on increase in accounts
receivable and inventory (14%).................
Income before taxes......................................
Taxes.............................................................
Income after taxes.........................................
d. Should the new cash discount policy be utilized? Briefly comment.
CP 7-1. Solution:
Logan Distributing Company
a. Accounts receivable = Average collection × Average daily
period sales
Before
Average collection period
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of McGraw-Hill Education.
Chapter 07: Current Asset Management
Average daily sales
( ) ( ) ( )
$400,000 .01 .30 $400,000
Credit sales Discount
360 days 360 days
$400,000 $1,200
360 days
$398,800
360 days
Average daily sales $1,107.78
-
-=
-
=
=
=
After
Average collection period
CP 7-1. (Continued)
of McGraw-Hill Education.
Chapter 07: Current Asset Management
( ) ( ) ( )
$600,000 .03 .50 $600,000
Credit sales discount
360 days 360 days
$600,000 $9,000
360 days
$591,000
360 days
Average daily sales $1,641.67
-
-=
-
=
=
=
b. Before
2SO
EOQ C
=
2 15,000 $200 $6,000,000 4,000,000 2,000 units
$1.50 $1.50
´ ´ = = =
After
2 22,000 $200 $9,000,000 6,000,000 2,449.49
$1.50 $1.50
´ ´ = = =
Average inventory
Before
2,000 1,000 units 1,000 units $12 $12,000
2= ´ =
Chapter 07: Current Asset Management
2,449.49
2=
c.
Before
Policy
Change
After
Policy
Change
Net sales (Sales – Cash discount) $398,800 $591,000
*Interest on increase in accounts
receivable and inventory
(14%) 3,550.45
*14% AR´
( )
14% $49,250.10 $26,586.72= ´ -
14% $22,663.38= ´
$3,172.87=
14% INV´
( )
=14% $14,697 $12,000´ -
14% $2.697= ´
$ 377.58=
$3,550.45
d. The new cash discount policy should be utilized. The interest
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