Question

Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by $150,000 if credit is extended to these new customers. Of the new accounts receivable generated, 5 percent will prove to be uncollectible. Additional collection costs will be 2 percent of sales, and production and selling costs will be 74 percent of sales. The firm is in the 35 percent tax bracket.

b. What will Johnson’s incremental return on sales be if these new credit customers are accepted?

Short answer

The incremental return on sales is 12.35%.

Step-by-step solution

Meaning of return on sales

The return on sales is used to evaluate the organization’s ability to convert its sales into profits. The return on sales is measured by dividing the operating profit by net sales of the organization.

Calculation of incremental return on sales

The incremental return on sales is 12.35%.

$\begin{array}{rcl}\mathrm{Incremental}\mathrm{return}\mathrm{on}\mathrm{sales}& =& \frac{\mathrm{Incremental}\mathrm{income}}{\mathrm{Incremental}\mathrm{sales}}\times 100\\ & =& \frac{\$18,525}{\$150,000}\times 100\\ & =& 12.35\%\end{array}$