Problem: The Tanner Corporation is a highly successful marketer of raw leather to producers of various lines of leather products. The company is considering expanding by selling to makers or custom leather automobile seats. Tanner's marketing VP Estimates that this market can add $700,000 in new sales. However, since many of the firms in the custom auto seat business are small independent companies, the financial V.P. estimates that 12 percent of the accounts will be uncollectible and he is arguing against the firm's expansion into this new market segment. The cost of producing and marketing the leather in this market is estimated to be 70 percent of sales. Tanner's tax rate is 35 percent. All sales are made on credit.
1) What will Tanner's incremental net income (after taxes) be it if enters the new market?
2) If Tanner has a receivables turnover ratio of 4 times and an inventory turnover ratio of 10 times, how much will the firm have to invest in new receivables and new inventory to support the sales in the new market segment?
3) If Tanner requires a minimum return on investment in assets of 18 percent, should the firm enter the new market...or is the financial VP correct in her assessment of the situation? Do some quick calculations and explain very briefly, why the firm should or should not enter the custom auto seat market.