Landis Apparel Co.
Case 7
Current Asset Management
Purpose: The case illustrates the relationship between profitability and required investment. The
turnover ratio for accounts receivable is particularly important, with an investment in inventory also
included in the analysis. Sensitivity analysis is further considered in this case.
Relation to Text: The case should follow Chapter 7.
Complexity: The case is reasonably straight forward and requires 30-45 minutes.
Solutions
1.
Additional sales
$1,000,000
Accounts Uncollectible (5% of new sales)
50,000
Annual incremental revenue
950,000
Collection costs (4% of new sales)
40,000
Production and selling costs (85% of new sales)
850,000
Annual income before taxes
60,000
Taxes (35%)
21,000
Annual incremental income after taxes
$39,000
2.
Accounts Receivable =
Sales
=
$1,000,000
=
$333,333
Turnover
3
3.
Return on accounts
receivable investment
=
Annual incremental income after tax
=
$39,000
Accounts receivable
$333,333
4.
No. The return on investment is only 11.70%, versus a required rate of return of 14%.
5.
New Accounts
Receivable
=
Sales
=
$1,000,000
=
$250,000
Turnover
4
Return on accounts
receivable investment
=
Annual incremental income after tax
=
$39,000
= 15.60%
Accounts receivable
$250,000
Yes. The return on investment is 15.60%, versus a required rate of return of 14%.
6.
First compute the total investment
Accounts receivable
$250,000
Inventory
200,000
Total Investment
$450,000
Return on total investment
=
Annual incremental income after tax
=
$39,000
= 8.67%
Total investment
$450,000
No. The return on investment is 8.67%, versus a required rate of return of 14%.
7.
First compute the revised aftertax income
Additional sales
$1,000,000
Accounts Uncollectible (5% of new sales)
50,000
Annual incremental revenue
950,000
Collection costs (4% of new sales)
40,000
Production and selling costs (75% of new sales)
750,000
Annual income before taxes
160,000
Taxes (35%)
56,000
Annual incremental income after taxes
$104,000
Then compute return on total investment.
Return on total investment
=
Annual incremental income after tax
=
$104,000
= 23.11%
Total investment
$450,000
The sale should be made. The return on investment is 23.11% versus the required return of
14%.