Question

Landis Apparel Co.

Ruth Landis, the CEO of Landis Apparel Co., is evaluating the firm's sales prospects for 2016. The company, based in Southern California, has grown from a small business into a significant player in the women's clothing industry, with sales slightly exceeding $100 million. Ruth and her husband, Jim, who serves as the CFO, have witnessed this growth. The company produces its brand of clothing and also sells licensed brands from renowned designers. Landis has manufacturing plants in Southern California, South America, and Asia, which produce dresses, sweaters, and other apparel.

One critical aspect of their business is deciding which customers are eligible for credit extension. In the fashion industry, few customers pay in cash, making credit extensions vital. While the credit department handles routine decisions, more complex situations require Ruth and Jim Landis's final approval.

The Potential Account

The credit department has presented the potential account of Monique Fashion Stores, which is seeking a $1 million credit for purchases. Based on Monique's Dun & Bradstreet rating and industry data, there is a 5% chance of non-payment if credit is extended. Collection costs amount to 4% of sales, while production and selling costs make up 85% of sales. Profits will be taxed at a 35% rate. Landis Apparel Co. expects accounts receivable turnover to be three times, and the firm's required return on investment is 14%.

Questions:

1. Using methods similar to those discussed in An Actual Credit Decision" in Chapter 7 of the Block, Hirt, and Danielson text, calculate the Annual Incremental Income after Taxes" from making the sale to Monique Fashion Stores.

2. Assuming that the sole new investment is in accounts receivable, what would be the investment in accounts receivable based on the three times turnover ratio?

3. Calculate the return on accounts receivable based on your answers to questions one and two.

4.Considering that the company has a required return on investment of 14%, should Landis Apparel Co. proceed with the sale to Monique Fashion Stores?

5. If the accounts receivable turnover ratio were four times, with all other percentages remaining the same, should Landis Apparel Co. make the sale?

6.Now, suppose that an additional $200,000 in inventory must be maintained throughout the year, in addition to the accounts receivable balance calculated in question 5. Should Landis Apparel Co. proceed with the sale?

Answer 1

The answer details the step-by-step calculations and considerations for Landis Apparel Co. regarding the sale to Monique Fashion Stores.

Step-by-step explanation:

To calculate the Annual Incremental Income after Taxes from making the sale to Monique Fashion Stores, we need to determine the potential account's credit risk and the costs associated with non-payment. With a 5% chance of non-payment and collection costs amounting to 4% of sales, we can calculate the potential income after taxes.

Assuming the sole new investment is in accounts receivable, we can determine the investment based on the three times turnover ratio. To calculate the return on accounts receivable, we can use the information from the previous calculations.

Based on Landis Apparel Co.'s required return on investment of 14%, we can determine whether they should proceed with the sale or not. If the accounts receivable turnover ratio were four times, we can consider the impact on the decision. If an additional $200,000 in inventory must be maintained throughout the year, we can assess the effect on the sale.