Question

Gartshore, Inc., is a mail-order book company. The company recently changed its credit policy in an attempt to increase sales. Gartshore's variable cost ratio for obtaining credit is 70% and its required rate of return is 12%. The company projects that annual sales will increase from the current level of $360,000 to $432,000, but the average collection period on receivables will go from 30 to 40 days. Ignoring any tax implications, what is the cost of carrying additional investment in accounts receivable, using a 360-day year?

Answer 1

Answer is 1512

Step-by-step explanation:

The 70 percent VC (Variable Cost) would be taken the appropriate cost or added investment in A/R. The residual 30 percent goes to the base line.

a) (30 days) Before: 360,000*(30/360 days) = 360000*8.3% = 30000

b) (40 days) After: 432,000*(40/360 days) = 432000*11.%1 = 48000

Diff b/w Before and After = 18000 increase in Account receivable

18000*0.70 added investment cost = 12600

Required Return = 12600*0.12 = 1512