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CHAPTER 20

Accounts Receivable and Inventory Management

True/False

1. Accounts receivable are an asset that reflects sales made on credit.


ANSWER: True
DIFFICULTY: Easy
KEYWORDS: accounts receivable

2. For many industries, accounts receivable comprise as much as 25% of total assets.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: accounts receivable

3. Because the 2% discount is so small, terms of credit such as 2/10 net 30 do not have much affect on
accounts receivable management.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: accounts receivable management

4. Accounts receivable variables under control of the financial manager include level of credit sales, terms
of credit sales, and quality of credit customers.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: accounts receivable, control of manager

5. If upon examination of a firm’s existing credit policy it is discovered that bad debt losses have
increased for certain credit groups, it does not follow that extension of credit to those groups should be
withheld.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: credit policy

6. Carrying inventory reduces the costs associated with periodic bad debt losses.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: carrying inventory

7. The economic ordering quantity (EOQ) model calculates the size of the firm’s inventory given its
expected usage, carrying costs, and ordering costs.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: EOQ model

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8. The optimal ordering quantity for the EOQ model is the quantity for which the sum of the costs of
ordering and carrying inventory is maximized.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: EOQ model

9. Non-uniform demand can be accomplished in the EOQ model by allowing for non-uniform ordering
costs.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: EOQ model

10. Terms of sale are frequently changed by the financial manager in order to increase sales.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: terms of sale

11. The accounts receivable aging schedule provides a method for monitoring the collection of accounts
receivable.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: monitoring collections

12. Credit scoring is a numerical procedure for evaluating the credit-worthiness of an individual.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: credit scoring

13. The main disadvantage of credit scoring is that the credit scorer needs substantial training.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: credit scoring

14. Inventory relative to total assets for all industries is lower than accounts receivable relative to total
assets for all industries.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: inventory to total assets

15. Anticipatory buying occurs because of an anticipated decrease in interest rates.


ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: anticipatory buying

16. Collection of accounts receivable is not affected by customer type.


ANSWER: False
DIFFICULTY: Easy
KEYWORDS: accounts receivable collection

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17. The nature of a company’s business is an important factor in determining the level of credit sales.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: credit sales level, type of business

18. Because poor credit-worthy customers might cause bad debt losses, credit sales to them should not be
allowed.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: poor credit-worthy customers

19. The major disadvantage of credit scoring is that it is expensive.


ANSWER: False
DIFFICULTY: Easy
KEYWORDS: credit scoring

20. As inflation increases, the cost of carrying inventory decreases.


ANSWER: False
DIFFICULTY: Easy
KEYWORDS: inflation, cost of carrying inventory

21. Determination of safety stock involves a trade-off between the risk of a stock-out and increased costs of
carrying additional inventory.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: safety stock

22. In terms of trade credit, default costs vary indirectly with the quality of the customer.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: default costs

23. In the EOQ model, the carrying cost on inventory should include the required rate of an investment in
inventory.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: EOQ model

24. The EOQ model assumes constant demand and constant unit price.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: EOQ model

25. The just-in-time inventory control system is simply a new approach to the EOQ model which tries to
produce the lowest average inventory possible.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: just-in-time inventory

26. The decision to forego the discount available for those customers who pay early has an advantage as
well as a disadvantage.

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ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: foregoing discounts

27. According to the Altman model, the majority of firms with Z-scores less than 2.7 one year prior to
bankruptcy went bankrupt.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: Altman’s Z-score

28. Single-sourcing allows a firm to have more direct influence and control over the quality performance of
a supplier.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: single-sourcing

29. The assumption of instantaneous delivery and independent orders is dealt with by the inclusion of a
safety stock.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: safety stock

30. Marginal or incremental analysis involves a systematic comparison of the incremental returns and the
incremental costs from a change in the discount period, the risk class of the customer, or the collection
process.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: incremental analysis

31. If the incremental profit contribution from new sales is greater than the firm’s average credit costs, then
the change in credit policy should be undertaken.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: incremental profit contribution for sales

32. The percentage of credit sales to total sales plays a major role in determining a firm’s investment in
accounts receivable, but it generally is not within the control of the financial manager.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: investment in accounts receivable

33. Default costs vary indirectly with the quality of customer.


ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: accounts receivable management, default costs

34. Default costs vary directly with the quality of the customer.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: default costs

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35. The chance of default increases as the age of the account increases.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: collection of accounts receivable, default risk

36. Control of accounts receivable focuses on the control and elimination of past-due receivables.
ANSWER: True
DIFFICULTY: Easy
KEYWORDS: controlling accounts receivable

37. It is as important for a firm to analyze the costs associated with a credit policy change as it is for the
firm to analyze the change’s benefits.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: credit policy costs

38. Inventory control and management has the same importance for firms regardless of their industry.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: inventory control and management

39. As inventory uncertainty increases, safety stock decreases.


ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: safety stock

40. Safety stock is used to deal with the two most limiting assumptions of the EOQ model.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: safety stock, EOQ model

41. The purpose of carrying inventories is to uncouple the operations of the firm so that delays or
shutdowns in one area do not affect the production and sale of the final product.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: purpose of carrying inventory

42. The purpose of finished goods inventory is to uncouple the production function from the purchasing
function.
ANSWER: False
DIFFICULTY: Easy
KEYWORDS: raw materials inventory

43. Work-in-process inventory is higher for complex and lengthy production processes.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: work-in-process inventory

44. The purpose of finished goods inventory is to uncouple the production and sales functions.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: finished goods inventory

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45. The purpose of the stock of cash inventory is to uncouple the payment of bills and the collection of
accounts due.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: cash stocks

46. The importance of effective inventory management is inversely related to the size of the investment in
inventory.
ANSWER: False
DIFFICULTY: Moderate
KEYWORDS: effective inventory management

47. Long distances between suppliers make the just-in-time inventory control system easy to implement.
ANSWER: False
DIFFICULTY: Easy
KEYWORDS: just-in-time inventory system

48. The just-in-time system reduces the economic order quantity by reducing the cost of ordering new
inventory, and by reducing safety stock needs.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: just-in-time inventory system

49. Total quality management (TQM) led to a new inventory management philosophy called single-
sourcing.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: total quality management

50. The traditional view of quality allows for some acceptable defect level.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: traditional view of quality

51. Under the TQM view of the quality-cost trade-offs, for many products the optimal quality level is 100
percent quality.
ANSWER: True
DIFFICULTY: Moderate
KEYWORDS: total quality management

Multiple Choice

52. Which of the following is considered to be a spontaneous source of financing?


a. Operating leases
b. Accounts receivable
c. Inventory
d. Accounts payable

ANSWER: d
DIFFICULTY: Easy
KEYWORDS: spontaneous financing
53. Holding all other variables constant, an increase in _______________ will increase a credit score.

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a. total assets
b. working capital
c. earnings before interest and taxes
d. both b and c
e. all of the above

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: credit scoring

54. Which of the following is not considered in Altman’s Z-score?


a. Market value of debt
b. Retained earnings
c. Working capital
d. Sales

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: Altman’s Z-score

55. Carrying cost on inventory includes:


a. the required rate of return on investment in total assets.
b. wages of warehouse employees.
c. cost associated with inventory shrinkage.
d. both b and c.
e. all of the above.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: carrying cost

56. The EOQ model might lose its applicability during times of high inflation due to:
a. the cost of carry.
b. anticipatory buying.
c. quantity discounts.
d. lower prices.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: EOQ model, anticipatory buying

57. Determining how low inventory should be depleted before it is reordered is called the:
a. order point problem.
b. economic order quality.
c. stockout minimization issue.
d. ordering cost dilemma.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: order point problem

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58. Holding all other variables constant, an increase in the ___________ will increase the economic
ordering quantity.
a. carrying cost per unit
b. expected total demand
c. ordering cost per unit
d. both b and c
e. all of the above

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: economic ordering quantity model

59. Costs associated with discovering poor-quality products prior to delivery is called:
a. internal failure costs.
b. preventive costs.
c. appraisal costs.
d. external failure costs.

ANSWER: a
DIFFICULTY: Easy
KEYWORDS: internal failure costs

60. The TQM view argues that:


a. the costs of achieving higher quality are more than economists projected.
b. better quality products drive higher sales.
c. lost sales result from a poor-quality reputation.
d. both b and c.
e. all of the above.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: total quality management

61. A firm’s credit and collection policies usually include:


a. terms of sale, quality of customers, and collection of credit sales.
b. average collection period, dollar value of aged receivables, and terms of sales.
c. terms of sale and collection of credit sales.
d. terms of sale, level of credit sales, and collection of credit sales.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: credit and collection policies

62. An aging schedule of accounts receivable aids the financial manager in determining the:
a. amount of receivables that are past due.
b. average age of the customers.
c. receivables turnover.
d. average length of the discount period.

ANSWER: a
DIFFICULTY: Easy

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KEYWORDS: aging schedule of accounts receivable

63. A trade credit discount such as 2/10 net 30 means:


a. a 2% penalty is due after 30 days.
b. a 10% discount for cash on delivery and a 2% discount for payment within 30 days.
c. a 2% discount for payment within 10 days, and a 2% penalty if payment is made after 30 days.
d. a 2% discount if payment is made within 10 days; otherwise, the total amount is due in 30 days.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: trade credit discounts

64. If a firm with credit terms of 1/10 net 30 were to change its terms to 3/10 net 30, the result would
probably be:
a. increased bank loans.
b. increased accounts receivable turnover.
c. an increase in the average level of accounts receivable.
d. a decrease in accounts payable.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: change in credit terms

65. The purpose of carrying inventory is to:


a. make different production processes more dependent on sales.
b. make sales more independent of the production process.
c. have collateral for loans.
d. improve the current ratio.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: purpose for carrying inventory

66. A company-wide systems approach to quality is called:


a. total quality management.
b. single-sourcing management.
c. economic ordering quantity management.
d. just-in-time management.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: total quality management

67. Of the following EOQ model assumptions, the most limiting is:
a. uniform demand.
b. constant unit price.
c. constant ordering costs.
d. independent orders.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: EOQ model

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68. In the basic model, the optimal inventory level is the point at which:
a. total cost is minimized.
b. total revenue is maximized.
c. carrying costs are minimized.
d. ordering costs are minimized.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: optimal inventory level

69. The problems of uncertainty associated with both delivery time and product demand:
a. decrease the usefulness of the basic EOQ model.
b. result in higher carrying costs.
c. reduce inflationary pressure on purchases.
d. result in lower carrying costs.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: uncertainty and carrying costs

70. Which of the following industries has the lowest ratio of accounts receivable to total assets?
a. Construction
b. Food stores
c. Automotive dealers and service stations
d. Apparel and accessory stores

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: industry accounts receivables

71. Which of the following industries has the highest ratio of inventory to total assets?
a. Food stores
b. Automotive dealers and service stations
c. Electric utility
d. Contract construction

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: industry inventory

72. If the variables in the EOQ inventory model are defined as: S = total units demanded during the
planning period; O = ordering costs per order; C = carrying costs per unit; and Q = inventory order size
in units, how many orders will the company make during the planning period?
a. S/Q
b. O/Q
c. S/OQ
d. Q/S

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: EOQ model

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73. If the variables in the EOQ inventory model are defined as: S = total units demanded during the
planning period; O = ordering costs per order; C = carrying costs per unit; and Q = inventory order
size in units, then the average level of inventory which a company should have during the planning
period is:
a. 2/3 Q.
b. 1/2 Q.
c. SO.
d. 1/2 S.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: EOQ model

74. Determine the effective annualized cost of foregoing the trade discount on terms 3/10 net 90 (round to
the nearest .1%).
a. 13.3%
b. 13.5%
c. 13.7%
d. 13.9%

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

75. Determine the effective annualized cost of foregoing the trade discount on terms 2/10 net 45 (round to
the nearest .1%).
a. 21.0%
b. 20.3%
c. 19.0%
d. 18.6%

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

76. Determine the effective annualized cost of foregoing the trade discount on terms 1/10 net 40 (round to
the nearest .1%).
a. 11.2%
b. 11.8%
c. 12.1%
d. 12.9%

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

77. What is the effective annualized cost of foregoing the trade discount on terms 2/20 net 90 (round to the
nearest .1%)?
a. 9.2%
b. 10.5%
c. 11.4%
d. 12.3%

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ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

78. What is the effective annualized cost of foregoing the trade discount on terms 3/30 net 80?
a. 18.5%
b. 20.4%
c. 22.3%
d. 24.1%

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

79. Which of the following terms has the highest annualized cost for foregoing the trade discount?
a. 2/20 net 90
b. 2/10 net 80
c. 1/10 net 40
d. 1/10 net 20

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

80. What is the effective annualized cost of foregoing the trade discount on terms 2/10 net 80 (round to the
nearest .1%)?
a. 9.0%
b. 10.5%
c. 11.3%
d. 12.0%

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

81. What is the effective annualized cost of foregoing the trade discount with terms 2/15 net 70 (round to
the nearest .1%)?
a. 13.1%
b. 13.4%
c. 14.3%
d. 14.7%

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

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82. Sterling Clips, Inc. estimates that it will sell 10,000 porcelain clips next year. Because porcelain clips
are so easily damaged, the average per-unit carrying cost of the clips is $10. The per-order cost of
ordering is $250. Assume that Sterling wants a safety stock of 200 clips. If Sterling reorders the clips
based on the economic order quantity, what is Sterling’s average inventory of porcelain clips (round to
the nearest 10 clips)?
a. 350
b. 450
c. 550
d. 650

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: average inventory

83. Dorning Shade Company will use an estimated 50,000 gumbands in its manufacturing process next
year. The carrying cost of gumband inventory is $.04 per unit, and the cost of reordering gumbands is
$50 per order. What is Dorning Shade’s economic ordering quantity for gumbands (round to the nearest
100 gumbands)?
a. 11,200
b. 10,700
c. 9,700
d. 8,100

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: EOQ model

84. Stern Corporation uses semi-hex joints in its manufacturing process. If Stern’s total demand for the
joints for next year is estimated to be 15,000 units, and if the cost per order is $80, what is Stern’s
economic order quantity of semi-hex joints? Assume that carrying costs for semi-hex joints are $.51 per
unit and round off to the nearest 100 units.
a. 1,600
b. 1,800
c. 2,000
d. 2,200

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: EOQ model

85. Stern Corporation uses semi-hex joints in its manufacturing process. Stern’s total demand for the joints
for the next year is estimated to be 15,000 units, and the cost per order is $80. Assume that carrying
costs for semi-hex joints are $.51 per unit and that Stern maintains a safety stock of 500 units. What is
Stern’s average inventory of semi-hex joints?
a. 1,135
b. 1,316
c. 1,407
d. 1,585

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: average inventory

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86. The Steady Fork Company will use an estimated 4,000 wheel assemblies in its manufacturing process
next year. The carrying cost of the wheel assembly inventory is $.60 per wheel, and the ordering cost
per order is $20. What is Steady Fork’s economic ordering quantity of wheel assemblies (round to the
nearest unit)?
a. 215
b. 365
c. 417
d. 516

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: EOQ model

87. Uncertainty regarding product demand and delivery time for replenishing stock affects the size of a
safety stock inventory. In this regard, which of the following statements are correct?
i. The more certain is the delivery time for replenishing stock, the more safety stock is needed.
ii. The less certain is the delivery time for replenishing stock, the more safety stock is needed.
iii. The more certain is product demand, the more safety stock is needed.
iv. The less certain is product demand, the more safety stock is needed.
a. i and iii
b. ii and iii
c. i and iv
d. ii and iv

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: safety stock

88. With regard to the optimal order quantity (Q*), which of the following statements are correct?
i. As carrying cost per unit increases, Q * increases.
ii. As total demand over the planning period increases, Q * increases.
iii. As ordering cost per unit increases, Q* increases.
a. i only
b. ii only
c. ii and iii
d. i, ii, and iii

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: optimal order quantity

89. How do interest rates affect the optimal order quantity (Q *)?
a. As interest rates increase, Q* decreases.
b. As interest rates decrease, Q* decreases.
c. As interest rates increase, Q* increases until it reaches a maximum, after which any further
increase in interest causes a decline in Q*.
d. Interest rates do not affect Q*.

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ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: optimal order quantity

90. Which of the following is generally under the control of the financial manager?
a. Percentage of credit sales to total sales
b. Actual level of sales
c. Credit policies
d. Paying practices of customers

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: financial management, credit policies

91. Which of the following is a category of inventory?


a. Raw materials
b. Work-in-progress
c. Finished goods
d. All of the above

ANSWER: d
DIFFICULTY: Easy
KEYWORDS: categories of inventory

92. In the EOQ model, carrying costs of inventory include:


a. the required rate of return on inventory.
b. wages for warehouse workers.
c. costs associated with inventory shrinkage.
d. all of the above.

ANSWER: d
DIFFICULTY: Easy
KEYWORDS: EOQ model

93. Credit and collection policies affect all of the following except:
a. level of sales.
b. length of time before credit sales are collected.
c. terms of sales.
d. pricing policies.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: credit and collection policies, pricing

94. Which of the following is a characteristic of a just-in-time inventory control system?


a. Convenient location
b. High ordering cost
c. Low safety stock
d. Both a & c
e. All of the above

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ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: just-in-time inventory system

95. The EOQ model assumes which of the following is held constant?
a. Demand
b. Unit price
c. Ordering costs
d. Both a and c
e. All of the above

ANSWER: e
DIFFICULTY: Easy
KEYWORDS: EOQ model

96. An increase in _______________________ might occur when a firm increases its collection efforts.
a. inventory costs
b. bad debts
c. sales
d. average collection period

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: increasing collection, bad debts

97. Modification of the EOQ model by redefining total costs and solving for the optimum order quantity
can handle all of the following assumptions except:
a. constant ordering costs.
b. independent orders.
c. constant unit price.
d. constant carrying costs.

ANSWER: b
DIFFICULTY: Easy
KEYWORDS: EOQ model

98. Inflation affects the EOQ model in all of the following ways except:
a. changing the investment in accounts receivable.
b. encouraging anticipatory buying.
c. increased carrying costs.
d. encouraging buying early to avoid price increases.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: inflation, EOQ model

99. Increased investment due to the delay in collections of accounts receivable because existing customers

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take advantage of a new extended credit period is equal to the:
a. average collection period on new collectable sales times the daily level of original collectable sales.
b. variable costs as a percentage of sales times average collection period on old collectable sales times
the daily level of original collectable sales.
c. change in the average collection period on original collectable sales times the daily level of original
collectable sales.
d. none of the above.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: collecting accounts receivable

100. The marginal increase in investment in accounts receivable due to attraction of new customers equals
the increase in collectable sales times:
a. variable costs.
b. average collection period for new collectable sales.
c. variable costs times average collection period for new collectable sales.
d. average collection period for old collectable sales times variable costs.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: increase in accounts receivable

101. Accounts receivable and inventory should be self-liquidating through the:


a. aging of accounts receivable.
b. cash conversion cycle.
c. average collection period.
d. sales-to-receivables collection cycle.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: accounts receivable and inventory, self-liquidating accounts

102. The only true accounts receivable management decision variables under the control of the financial
manager are:
a. the terms of sale and quality of customer.
b. the level of sales.
c. the percent of credit sales to total sales.
d. the paying practices of customers.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: accounts receivable management

103. Which of the following is a characteristic of credit scoring?


a. Low cost
b. Easy to implement
c. Used to spot credit risks
d. All of the above

ANSWER: a
DIFFICULTY: Easy

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KEYWORDS: credit scoring

104. If a firm offers credit terms of 2/10 net 30, the annualized opportunity cost to its customers of
foregoing the discount is:
a. 18.31%.
b. 20.04%.
c. 24.49%.
d. 36.73%.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

105. Three loan applicants have provided the following information:

Market Value Retained Working


EBIT Sales of Equity Earnings Capital
Total Total Book Value Total Total
Assets Assets of Debt Assets Assets
Applicant A 0.2 0.8 1.0 0.3 0.8
Applicant B 0.1 0.4 1.2 0.4 0.4
Applicant C 0.3 0.7 0.5 0.4 0.7

If we use Altman’s Z-score as a preliminary hurdle to determine to whom we should extend credit,
then:
a. we would extend credit to all three applicants.
b. we would extend credit to applicants A and B but not to applicant C.
c. we would extend credit to applicants A and C but not to applicant B.
d. we would extend credit to applicants B and C but not to applicant A.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: extending credit to applicants

106. The financial manager can determine whether or not accounts receivable are under control by:
a. examining the ratio of credit sales to receivables.
b. examining the amount of bad debts relative to sales over time.
c. comparing the current aging of receivables with past data.
d. all of the above.

ANSWER: d
DIFFICULTY: Easy
KEYWORDS: financial manager and accounts receivables

Use the following information to answer questions 107-112. Assume that your firm is considering
relaxing its current credit policy. Currently the firm has annual sales, all credit, of $16 million and
an average collection period of 30 days. The firm is considering a change in credit terms from the
current terms of net 30 to 1/30 net 60. The change is expected to generate additional sales of $2
million. The firm has variable costs of 75% of the selling price. The information provided here, plus
additional information, is summarized in the table below.

New sales (all credit) $18,000,000

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Original sales (all credit) $16,000,000
Contribution margin 25%
Percent bad debt losses on new sales 6%
New average collection period 45 days
Original average collection period 30 days
Additional inventory investment $50,000
Pre-tax required rate of return 15%
New percent cash discount 1%
Percent of customers taking the discount 50%

107. If the credit policy change is made, the change in bad debt losses will be:
a. $180,000.
b. $160,000.
c. $120,000.
d. $90,000.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: change in bad debt losses, change in credit policy

108. If the credit policy change is made, the change in profit will be:
a. $200,000.
b. $380,000.
c. $400,000.
d. $550,000.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: change in profit, change in credit policy

109. If the credit policy change is made, the additional investment in accounts receivable will be:
a. $733,333.
b. $850,000.
c. $916,667.
d. $1,067,333.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: change in credit policy, accounts receivables

110. If the credit policy change is made, the cost of the additional investment in accounts receivable and
inventory will be:
a. $145,000.
b. $137,500.
c. $128,000.
d. $114,500.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: change in credit policy, accounts receivable and inventory
111. If the credit policy change is made, the change in the cost of the cash discount will be:
a. $80,000.

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b. $90,000.
c. $100,000.
d. $110,000.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: change in credit policy, cost of cash discount

112. If the credit policy change is made, the net effect (i.e., incremental revenues versus incremental costs)
will be:
a. $375,000.
b. $265,000.
c. $145,000.
d. $85,000.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: change in credit policy

113. A firm expects total demand for its product over the planning period to be 10,000 units with an
ordering cost per order of $400 and a carrying cost per unit of $2. This firm’s economic ordering
quantity is:
a. 1,000.
b. 2,000.
c. 3,000.
d. 4,000.

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: EOQ model

114. A firm expects total demand for its product over the planning period to be 80,000 units with an
ordering cost per order of $400 and a carrying cost per unit of $4. This firm’s economic ordering
quantity is:
a. 1,000.
b. 2,000.
c. 3,000.
d. 4,000.

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: EOQ model

115. Safety stock:


a. is used to deal with the two most limited assumptions of the EOQ model.
b. must be higher the more certain are the inflows and outflows from the inventory.
c. will be lower when costs of carrying additional inventory are low.
d. does not affect average inventory levels.

ANSWER: a
DIFFICULTY: Easy

20
KEYWORDS: safety stock

116. Which of the following will have the most influence on the amount of investment a firm will have tied
up in accounts receivable?
a. Inventory turnover
b. The volume of credit sales
c. The rate of interest the firm is presently paying for short-term loans
d. Salaries of collection personnel

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: accounts receivable investment, volume of credit sales

117. Which of the following influences the amount of investment a firm will have tied up in accounts
receivable?
a. Terms of sale
b. Volume of credit sales
c. Collection efforts
d. Credit-worthiness of customers
e. All of the above

ANSWER: e
DIFFICULTY: Easy
KEYWORDS: accounts receivable investment

118. If a firm offers selling terms of 2/10, net 30, what is the opportunity cost to the customer if the discount
is passed up? Assume a 360-day year.
a. 22.3%
b. 24.5%
c. 30.6%
d. 36.7%

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

119. The best method of evaluating the quality of a firm’s accounts receivable is by monitoring the:
a. current ratio.
b. average collection period.
c. aging schedule.
d. quick ratio.

ANSWER: c
DIFFICULTY: Easy
KEYWORDS: evaluating quality of accounts receivable

120. Monopoly Corp. is projecting sales of $12 million next year. All sales will be on a credit basis. The
present average collection period is 45 days. Monopoly is considering a change in selling terms from
net 30 days to 2/10, net 30 in order to speed up the collection of its receivables. Studies indicate that
one half of the firm’s customers will take the discount. If Monopoly offers this discount, how much
will it cost next year? Assume a 365-day year.
a. $87,000

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b. $98,000
c. $103,000
d. $112,000
e. $120,000

ANSWER: e
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

121. Spretzel Pretzel is projecting annual sales of $37 million next year, from which it expects to generate
pre-tax profits of 8%. All sales are on a credit basis. The firm is very conservative, as it only offers
terms to AAA credit rated firms. Therefore, management is evaluating the prospect of liberalizing its
credit policies in order to attract new customers. Studies indicate that if Spretzel proceeds with this
change, the sales projection will increase to $42 million, its pre-tax profit margin will remain the same,
but bad debts are expected to rise by $210,000. If Spretzel proceeds, what will the firm’s pre-tax profit
be?
a. $2,760,000
b. $2,950,000
c. $3,150,000
d. $3,250,000

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: pre-tax profit, liberalizing credit policies

122. Assume that a firm liberalizes its credit policy in order to increase sales. Which of the following would
the firm expect to occur?
a. An increase in the average collection period
b. A decrease in bad debt expense
c. A loss of customers
d. A decrease in the average collection period

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: liberalizing credit policies

123. Assume that a firm implemented a just-in-time inventory control system in order to reduce the required
investment in inventory. All else equal, which of the following would occur?
a. The Capital Asset Pricing Model (CAPM) would rise.
b. Inventory turnover would decline.
c. Return on investment would improve.
d. The debt ratio would be lowered.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: just-in-time inventory control system

124. Which of the following describes what will be most likely to occur if a firm uses a level production
schedule when its sales are quite seasonal?

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a. As sales decrease, accounts receivable remain level.
b. As sales decrease, inventory will decrease.
c. As sales decrease, inventory will increase.
d. As sales increase, accounts payable will remain constant.

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: level production schedule, seasonal sales

125. Assume that a firm expects total demand for its product during the planning period to be 10,000 units.
If the cost of placing an order is $375 and carrying costs per unit are $1.75, what is the firm’s economic
order quantity in units?
a. 1,227
b. 2,070
c. 3,714
d. 4,650

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: EOQ model

126. The management of inventory is important because:


a. carrying too much inventory can result in a loss of efficiency and profitability.
b. carrying excessive inventory can result in a loss of sales.
c. carrying too little inventory can decrease the average collection period.
d. carrying too little inventory will adversely affect the firm’s CAPM.

ANSWER: a
DIFFICULTY: Moderate
KEYWORDS: inventory management

127. How does inflation affect a firm’s EOQ?


a. Increases manufacturing overhead
b. Increases the firm’s inventory turnover
c. Increases carrying costs
d. Does not affect a firm’s EOQ

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: EOQ model, inflation

128. Last year, Bell Computer made a decision not to carry any finished goods in stock but would only sell
products upon the placement of orders. To accomplish this, the firm implemented a just-in-time

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inventory control system. As a result, Bell is projecting an increase in its inventory turnover from 6.0 to
8.0. Sales are projected to be $880 million this year; cost of goods sold is expected to be 50% of sales.
How much less inventory will implementation of the just-in-time inventory control allow Bell
Computer to carry in the coming year?
a. $14.1 million
b. $18.3 million
c. $23.3 million
d. $36.0 million

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: just-in-time inventory

129. Which of the following types of business would you expect to have the smallest percentage of their
total assets invested in accounts receivable?
a. Construction firms
b. Steel manufacturers
c. Fast food restaurants
d. All of the above would have about the same investment in accounts receivable, as a percent of total
assets

ANSWER: c
DIFFICULTY: Moderate
KEYWORDS: industry and accounts receivable

130. Which of the following types of business would you expect to have the largest percentage of their total
assets invested in finished goods inventory?
a. Fast food restaurants
b. Automobile dealerships
c. Hotels
d. All of the above would have about the same investment in inventory, as a percent of total assets

ANSWER: b
DIFFICULTY: Moderate
KEYWORDS: industry and finished goods inventory

131. TQM has encouraged which of the following?


a. Antagonistic relationships between suppliers and customers
b. More shopping around for cheaper sources of inventory
c. Multi-sourcing
d. Closer, more harmonious relationships between suppliers and customers

ANSWER: d
DIFFICULTY: Moderate
KEYWORDS: total quality management

Short Answer

24
132. Discuss the weaknesses of the EOQ model.

ANSWER: The EOQ model assumes that demand is constant and uniform, which can cause a
problem if demand varies from day to day. If demand is stochastic, the model should be modified
to include safety stock. Second, the model assumes a constant unit price. The model would have to
be modified if quantity discounts are being offered. Third, it assumes constant carrying costs. The
unit cost of carry will vary as the level of inventory rises due to such things as economies of scale.
Fourth, there is an assumption of constant ordering costs. Fifth, the model assumes instantaneous
delivery. Once again, if this is not so, safety stock will have to be added into the model. Last, orders
are assumed to be independent. This could create a problem for firms that combine orders to save
on costs.
DIFFICULTY: Moderate
KEYWORDS: EOQ model, assumptions

133. Explain the effects of inflation on the EOQ model.

ANSWER: Inflation affects the EOQ model in two ways. First, although the EOQ model can be
modified to assume constant price increases, often major price increases occur only once or twice a
year and are announced ahead of time. If this happens, the EOQ model will lose its applicability
and might be replaced with anticipatory buying. The costs include the added carrying cost
associated with the inventory and the benefits come from buying at a lower cost. The second way
that inflation affects the EOQ is through increased carrying costs. As inflation increases interest rates,
the cost of carrying inventory increases.
DIFFICULTY: Moderate
KEYWORDS: EOQ model, inflation

134. You purchase $5,000 worth of supplies every 60 days and never take the trade discount of 2/10 net 60.
How much could you save each (360-day) year if you took the discount?

ANSWER:
2% × $5,000 = $100
Six 60-day periods per year
$100 × 6 = $600
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

135. What is the effective annualized (365 days) cost of foregoing a trade credit discount of 3/10 net 45?

ANSWER:
Annualized opportunity cost of foregoing trade discount =
0.03/(1 - 0.03) × 365/(45 - 10) = 32.25%
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

136. Fiesta Taco Company purchases 10,000 boxes of ground beef each year. It costs $10 to place each order
and $5 per year for each box held as inventory.
a. What is the average inventory held during the year?
b. What is the economic order quantity for the ground beef?
c. How many orders will be made each year?

ANSWER:
a. Average inventory held = (Q/2) = (10,000/2) = 5,000 boxes

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b. Q* = = = 200 boxes
20S / C [( 2)(10)(10,000)] / 5
c. Number of orders per year = S/Q* = 10,000/200 = 50 orders
DIFFICULTY: Moderate
KEYWORDS: EOQ model, average inventory

137. It costs a local appliance store $25 per unit annually for storage, insurance, etc., to hold television sets
in their inventory. Sales this year are anticipated to be 750 units. Each order costs $15.
a. How many orders should be made during the year?
b. It takes approximately two weeks to receive an order after it has been placed. If the store insists on a
one-week safety stock (assume 50 weeks), what should the inventory level be when a new order is
placed?

ANSWER:
a. Q* = = = 30 sets
20S / C (2)(15)(750) / 25
Number of orders per year = (S/Q*) = (750/30) = 25
b. One-week safety stock = 15 sets
Two-week order lag = 30 sets
Order point = 45 sets
DIFFICULTY: Moderate
KEYWORDS: safety stock

138. Fran’s Bookstore receives a shipment of books every month with credit terms of 3/15 net 60. The
bookstore is currently paying its bills every 60 days. A bright MBA student suggested that the
bookstore borrow the money necessary to take the discount from a local bank at 18% interest. Should
the bookstore implement the policy suggested by the MBA student? Assume a 360-day year.

ANSWER:
Cost of foregoing the discount = [.03/(1 - .03)] × (360/45) = 24.74%
Cost of borrowing from the bank = 18%
The bookstore should borrow money from the bank to take the discount.
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

139. Manfred Manufacturing is involved in the production of machine parts. The company uses 500,000
pounds of steel annually. The current purchasing cost for steel is $2.20 per pound. The carrying cost for
inventory is 20% of the purchase price. The cost of ordering steel is $1,000 per order. The company has
decided to maintain a safety stock of 20,000 pounds. The delivery time per order is 10 days. The
company works 365 days a year.
a. Determine the optimal EOQ.
b. How many orders will be placed annually?
c. What is the average inventory?
d. What is the inventory order point? (That is, at what level of inventory should a new order be
placed?)
e. What is the company’s total inventory costs for the year?

ANSWER:

26
a. Q* = )] = 47,673 lbs.
[( 2)(500,000)($1,000)] /[(. 20)($ 2.20)]
b. Number of orders placed annually = (500,000/47,673) = 10.488.
c. Average inventory = (47,673/2) + 20,000 = 43,836 lbs.
d. 20,000 lbs + 13,699 lbs. = 33,699 lbs.
e. Total inventory costs = (43,836)(.20)($2.20) + 10.488 ($1,000) =$29,776.
DIFFICULTY: Moderate
KEYWORDS: EOQ model

140. The terms of sale given by a company were 3/10 net 60.
a. Their customers would get a discount if they paid within how many days?
b. The discount would be __________.
c. If they do not take advantage of the discount, when must the account be paid?
d. What is the annualized opportunity cost of foregoing the discount?
(Hint: use a 360-day year in calculations.)

ANSWER:
a. 10 days
b. 3% of the total sale
c. Within 60 days of the date of sale
d. Opportunity cost = [.03/(1 - .03)] × [360/(60 - 10)] = 22.27%
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

141. A flower shop is trying to determine the optimal order quantity of the wicker baskets that it places
many of its arrangements in. The store thinks it will sell 2,000 of these baskets over the next year. The
baskets cost the shop $2.00 each. The carrying costs of the baskets are $0.15 each per year. It costs the
shop $8.00 to order.
a. What is the economic order quantity?
b. What is the total cost for ordering the baskets once a year? Four times a year?

ANSWER:
a. Q* = = = 462 units
2SO/ C [2(2000)(8)] / .15)
b. Total cost: (Q/2)C + (S/Q)O
Ordering once: (2000/2)(.15) + (2000/2000)8 = $150 + $8 = $158
Ordering four times: (500/2)(.15) + (2000/500)8 = $37.50 + $32 = $69.50
DIFFICULTY: Moderate
KEYWORDS: EOQ model

142. The bike store orders $2,000 worth of supplies every 30 days. If they take advantage of the 3/10 net 30
discount offered by their supplier, how much would they save over the year? Assume a 360-day year.

ANSWER:
3% × $2,000 = $60 would be saved on each order
12 30-day periods in the year
12 × $60 = $720 would be saved over the year
DIFFICULTY: Moderate
KEYWORDS: effective cost of foregoing trade discount

27
143. A local lamp store expects to sell 2,000 lamps in the coming year. It costs the store $1.00 in
carrying costs for each lamp and $10.00 for each order placed.
a. What is the economic order quantity for the lamps?
b. How many orders will be placed each year?
c. If the store wants a one-week safety stock and it takes one week to receive an order after it has
been placed, what should the inventory level be when a new order is placed? Assume a 50-week
year.

ANSWER:
a. Q* = = = 200
2SO/ C [2(10)( 2000)] / 1
b. Number of orders = S/Q* = 2,000/200 = 10 orders per year
c. One-week supply = 2,000/50 = 40 lamps
Order level = safety stock + one-week order lag = 40 + 40 = 80 lamps is the order point
DIFFICULTY: Moderate
KEYWORDS: EOQ model

144. A pizzeria in downtown San Francisco is trying to determine the optimal order quantity for their pizza
ingredients. This pizzeria feels that it will sell 14,400 pizzas every year at an average price of $8 per
pizza. The store buys the ingredients for one pizza at a rate of $1.50, and costs for storing the
ingredients are $.80 per pizza. Ordering costs for more ingredients are $13.
a. Determine the economic order quantity.
b. What would be the total costs for ordering the ingredients one, four, five, 10, and 15 times a year?
c. What questionable assumptions are being made by the EOQ model?

ANSWER:
a. Q* = = = 684.11 units
2SO/ C [2(14,400)(13)] / .80)
b. Total costs = (_Q/S)(C) + (S/Q)(O)
Order one time: = $5,760 + $13 = $5,773
Order four times: = $1,440 + $52 = $1,492
Order five times: = $1,152 + $65 = $1,217
Order 10 times: = $576 + $130 = $706
Order 15 times: = $384 + $195 = $579
c. (1) Constant or uniform demand
(2) Constant unit price
(3) Constant carrying costs
(4) Constant ordering costs
(5) Instantaneous delivery
(6) Independent orders
DIFFICULTY: Moderate
KEYWORDS: EOQ model

145. A local furniture store purchases 25 new lamps per month. Order costs are $7 per order, and it costs
$1.00 per lamp to store.
a. What is the optimal order quantity of lamps for the store?
b. What questionable assumptions are being made by the EOQ model?

ANSWER:

28
a. Q* = = = = 19 boxes
2SO/ C [2(25)(7)] / 1.00 350
b. It assumes among other things that the lamps are not breakable.
Other assumptions include:
(1) Constant or uniform demand
(2) Constant unit price
(3) Constant carrying costs
(4) Constant ordering costs
(5) Instantaneous delivery
(6) Independent orders
DIFFICULTY: Moderate
KEYWORDS: optimal order quantity

146. A textile manufacturer has cloth that has a $14-per-yard carrying cost per year. This cloth is used at a
rate of 25,000 yards per year, and ordering costs are $10 per order.
a. What is the economic order quantity for this cloth?
b. What are the annual inventory costs for this firm if it orders in this quantity?

ANSWER:
a. Q* = = = 189 units
2SO/ C [2(25,000)(10)] / 14)
b. Total costs = [(Q/2)(C) + (S/Q)(L)]
= (189/2)($14) + (5,000/189)($10)
= $1,323 + $1,322.75 = $2,645.75
DIFFICULTY: Moderate
KEYWORDS: EOQ model

147. Susyoke Toys produces parts for toy trains and has the following costs:
1. Orders must be placed for parts to produce a group of 150 trains.
2. Annual unit usage is 300,000 (assume a 50-week year).
3. The carrying cost is 17% of the purchase price.
4. The purchase price is $1.20 per unit.
5. The ordering cost is $30 per order.
6. The desired safety stock is 800 units.
7. The delivery time is one week.

Given the above information:


a. Determine the optimal EOQ level.
b. How many orders will be placed annually?
c. What is the inventory order point?
d. What is the average inventory level?

ANSWER:
a. Q* = = = 9,393 units
2SO/ C [2(300,000)(30)] / .204)
b. (300,000/9,393) = 32 orders per year
c. Inventory order point = delivery time stock + safety stock
= (1/50) × 300,000 + 800
= 6,000 + 800 = 6,800 units
d. Average inventory = (EOQ/2) + safety time stock

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= (9,393/2 + 800 = 4,697 + 800 = 5,497 units
DIFFICULTY: Moderate
KEYWORDS: EOQ model

148. The Johnson Company has under study a new credit policy that they believe will increase annual sales
from $11 million to $14 million. However, the new plan is also expected to increase bad debt losses
from $800,000 to $1.2 million each year. The average collection period on collectable sales is now
averaging 90 days. This ratio will increase to 120 days for both old and new sales if this new credit
policy is adopted. The increase in sales is expected to increase the company’s investment in inventory
by $20,000. Assuming a pre-tax required rate of return of 25% and a variable cost-to-sales ratio of
60%, should the Johnson Company adopt the new credit policy? Assume a 360-day year.

ANSWER:
Step 1: Estimate the change in profit.
= ($3,000,000)(.40) - ($1,200,000 - $800,000)
= $1,200,000 - $400,000 = $800,000
Step 2: Calculate the additional investment in accounts receivable and inventory.
New A/R = ($14,000,000/360 × 120)-($11,000,000/360 × 90)
= $4,666,667 - $2,750,000 = $1,916,667
(New A/R + new inv.) × req. return
= ($1,916,667 + $20,000).25 = $484,167
Step 3: Estimate the change in the cost of cash discount (if a change in the cash discount is enacted)
= $0. (No change in the cash discount proposed.)
Step 4: Compare the incremental revenue with the incremental costs
= $800,000 - $484,167 = $315,833.
Since the benefits outweigh the costs, the proposed change should be made.
DIFFICULTY: Moderate
KEYWORDS: change in average collection period, cost of cash discount

149. Mountain Sports, Inc. is considering new credit policies in an effort to increase its sales. In spite of the
fact that relaxing the current standards will surely increase both bad debt losses and the average
collection period, the company’s financial manager believes that overall profitability could be
increased. He has estimated annual credit sales, bad debt losses, and the average collection period on
collectable sales for the proposed credit policy outlined below. Variable costs are 75% of sales and the
required rate of return is 20%. Which credit policy should Mountain Sports, Inc. adopt?

Present Policy Policy A


Annual credit sales $2,600,000 $3,000,000
Bad debt losses 70,000 90,000
Average collection period:
Old sales 30 days 40 days
New sales 40 days
Investment in inventory $ 50,000 $ 60,000

ANSWER:
Step 1: Estimate the change in profit.
= ($400,000 × .25) - $20,000
= $100,000 - $20,000
= $80,000
Step 2: Estimate the cost of additional investments in accounts

30
receivable and inventory.
Estimate additional investment in accounts receivable and inventory:
= ($3,000,000/360 × 40)-($2,600,000/360 × 30) + $10,000
= $126,667
Multiply this times the required rate of return:
= ($126,667).20
= $25,333
Step 3: Estimate the change in the cost of cash discount = $0 (no change).
Step 4: Compare the incremental revenue with the incremental costs.
= $80,000 - $25,333
= $54,667
DIFFICULTY: Moderate
KEYWORDS: comparing credit policies

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