US CMA Part 2 · Chapter 4 · Question 7 of 15
Jarvis Furnishings is considering relaxing its credit standards. Annual sales would increase by $400,000, its contribution margin ratio is 30%, and bad debts on the additional sales are expected to be 3%. Average investment in receivables would rise by $60,000, and the required return on that investment is 10%. What is the expected increase in annual pre-tax profit?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: D) $102,000
Explanation
Additional contribution = $400,000 x 30% = $120,000. Less bad debts = $400,000 x 3% = $12,000. Less financing cost of extra receivables = $60,000 x 10% = $6,000. Net increase = $120,000 - $12,000 - $6,000 = $102,000. The full $60,000 is an investment, not an annual cost; only its carrying cost is deducted.
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