CMA Study Group

Really want to know how to reach the correct answer ??

Correct answer is marked in the attached question .

The first step is to determine the average investment in receivables under each policy. Under the old policy, average daily sales are $ 986.30 ($360,000/365 days). Given a 30-day average collection period, the average receivables balance is $ 29,590 ($ 986.30 x 30 days). Under the new policy, average daily sales are $ 1,183.56 ($ 432,000/365 days), and the average receivables balance is $ 47,342 ($ 1,183.56 x 40 days). Hence, the average balance is $ 17,752 higher under the new policy. Because the company's incremental (variable) costs are 70% of sales, the extra investment is only $ 12,427 (70% x $17,752). The interest rate, or required rate of return, is 12%. Thus, the incremental carrying cost is $ 1,491 (12% x $12,427).

The cost of carrying the additional investment in accounts receivable is 12 percent of 70 percent of the increase in the average accounts receivable balance. The increase in accounts receivable is $17,761. The new average accounts receivable balance is $47,342, which is calculated as follows: $432,000 in sales divided by the accounts receivable turnover of 9.125 (365 days divided by the collection period of 40 days). The old average accounts receivable balance is $29,581, which is calculated as follows: $360,000 in sales divided by the accounts receivable turnover of 12.17 (365 days divided by the collection period of 30 days). The difference between the old and new accounts receivable balances is an increase of $17,761 (old = $29,581, new = $47,342), and this incremental amount is used to calculate the increased carrying cost. Increased carrying cost = (0.12)(0.7)($17,761) = $1,492

Thank you Gents . it is now Clear .