Accounts receivable changes without bad debts Tara’s Textiles currently has cred
ID: 2720918 • Letter: A
Question
Accounts receivable changes without bad debts Tara’s Textiles currently has credit sales of $360 million per year and an average collection period of 57 days. Assume that the price of Tara’s products is $60 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable change that will result in a 20.5% increase in sales and a 19.2% increase in the average collection period. No change in bad debts is expected. The firm’s equal-risk opportunity cost on its investment in accounts receivable is 13.1%. (Note: Use a 365-day year.)
a. Calculate the additional profit contribution from sales that the firm will realize if it makes the proposed change.
b. What marginal investment in accounts receivable will result?
c. Calculate the cost of the marginal investment in accounts receivable.
d. Should the firm implement the proposed change? What other information would be helpful in your analysis?
Explanation / Answer
Tara's Textiles All Amounts in $ million ; Quantities in millions a. Additional profit contribution from proposed change Existing sales quantity = $ 360 million / $ 60 = 6000000 6 million units Increase in Sales quantity = 20.5% Thus, increased sales units = 7.23 million units Additional Profit contribution from this change = 7.23 million units X $5 ($60 - $55) 36.15 million $ b. Original investment in accounts receivable (based on average collection period of 57 days) 57 = 365 / ($ 360 million / Accounts Receivable) Hence, Accounts Receivable = 57 X $ 360 million / 365 = 56.22 million $ Increase in collection period by 19.2% Hence, revised collection period for proposed change is 67.94 days Revised Sales Value = 7.23 million X $ 60 = 433.8 million $ Hence, the revised accounts receivable will be 67.94 X $ 433.8 million / 365 = 80.75 million $ Marginal investment in Accounts Receivable will be $ 80.75 million - $ 56.22 million = $ 24.51 million c. The cost the marginal investment in accounts receivable will be 13.1% of $ 24.51 million = 3.211 million $ d. For assessing whether the proposed change should be implemented or not, it is also necessary to ascertain the market trends for the sales price and cost of sales per unit, and whether the investment thus made will have any long-term or short-term benefits. Just from the marginal investment increase and the cost thereof, it can be inferred that the proposed change can be implemented.