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One way to arrive at this incorrect answer would be to use the cost of capital as a before-tax cost. The problem says that the 15% cost of capital is after tax. Please see the correct answer for a complete explanation.
To answer this question, we calculate the net income after tax generated by each of the four plans. We will include the cost of capital to carry the accounts receivable and inventory last, after we have calculated the Operating Income After Tax, since the cost of capital given in the problem is an after-tax cost. To calculate the cost of capital for each of the four proposed plans, we will multiply the average accounts receivable by 80% (the variable cost of the sales that the company has invested and needs to finance), add the average inventory to it, and multiply the total by the after-tax cost of capital to calculate the after-tax interest expense that will be required to carry the costs in the average accounts receivable and average inventory for one year. Plan A: (($20,000 × .8) + $40,000) × .15 = $8,400 Plan B: (($40,000 × .8) + $50,000) × .15 = $12,300 Plan C: (($60,000 × .8) + $60,000) × .15 = $16,200 Plan D: (($80,000 × .8) + $70,000) × .15 = $20,100 Net income calculations: Plan A: ($200,000 × .20) ? $1,000 ? $1,000 = $38,000 net operating income before tax. Net operating income after tax = $38,000 × .70 = $26,600. $26,000 ? $8,400 after-tax cost of capital = net income of $18,200. Plan B: ($250,000 × .20) ? $3,000 ? $2,000 = $45,000 net operating income before tax. Net operating income after tax = $45,000 × .70 = $31,500. $31,500 ? $12,300 after-tax cost of capital = net income of $19,200. Plan C: ($300,000 × .20) ? $6,000 ? $5,000 = $49,000 net operating income before tax. Net operating income after tax = $49,000 × .70 = $34,300. $34,300 ? $16,200 after-tax cost of capital = net income of $18,100. Plan D: ($350,000 × .20) ? $12,000 ? $8,000 = $50,000 net operating income before tax. Net operating income after tax = $50,000 × .70 = $35,000. $35,000 ? $20,100 after-tax cost of capital = net income of $14,900. The plan that will generate the highest net income is Plan B.
This is not the correct answer. Please see the correct answer for an explanation. We have been unable to determine how to calculate this incorrect answer choice. If you have calculated it, please let us know how you did it so we can create a full explanation of why this answer choice is incorrect. Please send us an email at support@hockinternational.com. Include the full Question ID number and the actual incorrect answer choice -- not its letter, because that can change with every study session created. The Question ID number appears in the upper right corner of the ExamSuccess screen. Thank you in advance for helping us to make your HOCK study materials better.
The information shows how various annual expenses such as bad debts and the cost of collections change as sales change. The average balance of accounts receivable and inventory have also been projected. The cost of the product to Foster is 80% of the selling price, after-tax cost of capital is 15%, and Foster's effective income tax rate is 30%. What is the optimal plan for Foster to implement?
