ACCT233 Tutorial 5 Questions

ACCT233 Tutorial 5 Questions
1. How does a firm’s required rate of return enter into the analysis of accounts
receivable management decisions?
A company uses rate of return when deciding if the company should take on a project or not.
The optimal cash budget is determined by accepting all investment projects who’s marginal
returns (measured by the rate of return) are greater than the marginal costs (measured by the
marginal cost of capital) of the investment. It enters into the analysis of account receivable
management decisions in terms of the bearing of the associated costs and revenues being
generated from the receivables. For example, if credit terms are tight there will be less of an
investment in accounts receivable and less bad debt but resulting in lower profits and sales.
2. How are the average collection period and an aging schedule used for credit
monitoring?
The average collection period is the average number of days between the date of a credit sale
is made and the date the purchaser pays for the credit owed. A company’s average collection
period show how effective the account receivable management practices are. Low average
collection period is more favourable than a high as this indicated the firms organization of
collecting payments is faster. However, this could indicate their credit terms are too strict and
customers may change to a provider with less strict payment terms as not everyone can pay
for things in cash or pay back their debts fast.
Aging schedules are used by managers to assess the financial performance of a company.
They relate directing to working capital management as they help companies predict their
cash flows. They do this by classifying the pending liabilities from earliest to latest and then
projecting the expected income by how many days ago the invoices were sent out. The
schedule could be used to estimate how many bad debts / receivables that are most likely not
be able to be collected. This points out issues in the businesses receivable practice, and
indicates that they may need to be able to change their systems.
Problems
Drake Paper company sells on terms of “net 30”. The firm’s variable cost ratio is 0.8.
1. If annual credit sales are $20 million and its accounts receivable average 15
days overdue, what is Drake’s investment in accounts receivable?
Average collection period = 30 + 15 = 45 days.

Average daily sales= annual sales/365= 20,000,000/365= $54,794.52
Investment in receivables= average daily sales x average collection period

= $54,794.52 x 45
= 4246575
2. Suppose that, as the result of a recession, annual credit sales decline by 10% to
$18 million, and customers delay their payments to an average of 25 days past
the due date. What will be Drake’s new level of accounts receivable
investment?
Investment in receivables= 18,000,000/365 x (30+25)
= $2712329
REQUIRED:
Given the above information,
i. Determine the marginal profitability of additional sales
Marginal profitability of additional sales = ($15,000,000-$11,000,000) x 0.20 -

($15,000,000 - $11,000,000) x 0.09
800000- 360000= 440000
ii. Determine the additional investment in accounts receivable
AR=ACP x sales/365
Before: AR= 30 x (11000000/365) = 904109
iii. Determine the cost of additional investment in accounts receivable
After: 45 x (15000000/365)= 1849315
Cost of additional AR- 945206
iv. Determine the cost of additional investment in inventory
90,000 x .15= 90000
v. Determine the additional bad-debt loss
.09 x 15000000= 1350000
vi. Determine the net change in pre-tax profits/losses

15000000- 945206- 90000- 1350000
= 147614794
vii. Should they go ahead with the change in credit policy?
Yes they should change the policy
3) Jenkins Supply Corporation sells $120 million of its products to wholesalers

on terms of “net 50”. Currently, the firm’s average collection period is 65
days. In order to speed up the collection of receivables, Jenkins is considering
offering a 1% cash discount if customers pay their bills within 15 days. The
firm expects 40% of its customers to take the discount and its average
collection period to decline to 40 days. The firm’s required pretax return on
receivables investment is 20%. Determine the net effect on Jenkins’ pretax
Unsure

ACCT233 Tutorial 5 Questions

Uploaded by

Copyright:

Available Formats

ACCT233 Tutorial 5 Questions

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACCT233 Tutorial 5 Questions

Uploaded by

Copyright:

Available Formats

ACCT233 Tutorial 5 Questions

Average collection period = 30 + 15 = 45 days.

Investment in receivables= average daily sales x average collection period

Given the above information,

i. Determine the marginal profitability of additional sales

Marginal profitability of additional sales = ($15,000,000-$11,000,000) x 0.20 -

800000- 360000= 440000

ii. Determine the additional investment in accounts receivable

Before: AR= 30 x (11000000/365) = 904109

iii. Determine the cost of additional investment in accounts receivable

After: 45 x (15000000/365)= 1849315

Cost of additional AR- 945206

iv. Determine the cost of additional investment in inventory

90,000 x .15= 90000

v. Determine the additional bad-debt loss

.09 x 15000000= 1350000

vi. Determine the net change in pre-tax profits/losses

vii. Should they go ahead with the change in credit policy?

Yes they should change the policy

3) Jenkins Supply Corporation sells $120 million of its products to wholesalers

You might also like