Question: Global Services is considering a promotional campaign that will increase annual credit sales by $400,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:
All $400,000 of the sales will be collectible. However, collection costs will be 4 percent of sales, and production and selling costs will be 76 percent of sales. The cost to carry inventory will be 8 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 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 $400,000 to arrive at income before taxes. Subtract taxes at a rate of 30 percent to arrive at income after taxes.
g. Divide the after tax return figure in part f by the total investment figure in part a. If the firm has a required return on investment of 12 percent, should it undertake the promotional campaign described throughout this problem?