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TUTORIAL 6 and 7

Price Corp. is considering selling to a group of new customers and creating new annual sales of $90,000.
5% will be uncollectible. The collection cost on these accounts is 3% of new sales, the cost of producing
and selling is 80% of sales and the firm is in the 30% tax bracket. What is the profit on new sales?


Waldron Inc. is considering selling to a group of new customers that will bring in credit sales of $24,000
with a return on sales of 5%. The only new investment will be in accounts receivable. Waldron has a
turnover ratio of 6 to 1 between sales and accounts receivable. What is the return on investment?


James Home Systems, Inc. is a well-known and reputable supplier of integrated circuits to manufacturers of
telecommunications devices. The firm is currently debating whether to expand its sales to car-telephone
manufacturers. While the firm expects an extra $2 million in sales if it enters this market, it also knows that
15% of its sales will ultimately be uncollectible. In addition, collection costs will be 2% on all new sales
and the firm's production and selling costs are 80% of sales. James Home's tax rate is 30%.
a) Calculate James Home's additional net income from the new sales.
b) If James Home can turn its receivables over 4 times per year, what will its additional investment in
accounts receivable be and what will the firm earn as an after-tax return on that investment?
c) James Home management requires that any new project earn a minimum of 12% return on
investment. Should the firm enter the car-telephone manufacturer market?


Tanner Co. is a highly successful supplier of leather to manufacturers of leather goods. Tanner is
considering expanding into the U.S. luxury auto seat market. It is estimated that although selling leather to
U.S. auto manufacturers will bring additional annual sales of $700,000, a high 12% of those accounts will
be uncollectible. The cost of conditioning and selling the leather is 70% of sales. Tanner's tax rate is 46%.
a) Calculate Tanner's incremental net income on the new sales.
b) Assume Tanner has a receivables turnover of 5. Calculate Tanner's incremental accounts receivable
investment and after-tax return on that investment.
c) Tanner's minimum required ROI is 15%. Should Tanner expand into the auto market?


McKinsee Inc. is developing a plan to finance its asset base. The firm has $5,000,000 in current assets, of
which 20% are permanent, and $12,000,000 in fixed assets. Long-term rates are currently 9.5%, while
short-term rates are at 7%. McKinsee's tax rate is 30%.
a) Construct a conservative financing plan with 80% of assets financed by long-term sources. If McKinsee's
earnings before interest and taxes are $6,000,000, what will their net income be?
b) An alternative and more aggressive plan would be to finance 60% of total assets with long-term
financing. Assuming that EBIT was again $6,000,000, what will net income be under this alternative?