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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.

Difficulty: Easy

Keywords: accounts receivable

2. For many industries, accounts receivable comprise as much as 25% of total assets.

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.

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.

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.

Difficulty: Moderate

Keywords: credit policy

6. Carrying inventory reduces the costs associated with periodic bad debt losses.

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.

Difficulty: Moderate

Keywords: EOQ model

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.

Difficulty: Moderate

Keywords: EOQ model

9. Non-uniform demand can be accomplished in the EOQ model by allowing for non-uniform ordering costs.

Difficulty: Moderate

Keywords: EOQ model

10. Terms of sale are frequently changed by the financial manager in order to increase sales.

Difficulty: Moderate

Keywords: terms of sale

11. The accounts receivable aging schedule provides a method for monitoring the collection of accounts receivable.

Difficulty: Easy

Keywords: monitoring collections

12. Credit scoring is a numerical procedure for evaluating the credit-worthiness of an individual.

Difficulty: Easy

Keywords: credit scoring

13. The main disadvantage of credit scoring is that the credit scorer needs substantial training.

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.

Difficulty: Moderate

Keywords: inventory to total assets

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

Difficulty: Moderate

Keywords: anticipatory buying

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

Difficulty: Easy

Keywords: accounts receivable collection

17. The nature of a company’s business is an important factor in determining the level of credit sales.

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.

Difficulty: Moderate

Keywords: poor credit-worthy customers

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

Difficulty: Easy

Keywords: credit scoring

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

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.

Difficulty: Moderate

Keywords: safety stock

22. In terms of trade credit, default costs vary indirectly with the quality of the customer.

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.

Difficulty: Moderate

Keywords: EOQ model

24. The EOQ model assumes constant demand and constant unit price.

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.

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.

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.

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.

Difficulty: Moderate

Keywords: single-sourcing

29. The assumption of instantaneous delivery and independent orders is dealt with by the inclusion of a safety stock.

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.

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.

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.

Difficulty: Moderate

Keywords: investment in accounts receivable

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

Difficulty: Moderate

Keywords: accounts receivable management, default costs

34. Default costs vary directly with the quality of the customer.

Difficulty: Moderate

Keywords: default costs

35. The chance of default increases as the age of the account increases.

Difficulty: Easy

Keywords: collection of accounts receivable, default risk

36. Control of accounts receivable focuses on the control and elimination of past-due receivables.

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.

Difficulty: Moderate

Keywords: credit policy costs

38. Inventory control and management has the same importance for firms regardless of their industry.

Difficulty: Moderate

Keywords: inventory control and management

39. As inventory uncertainty increases, safety stock decreases.

Difficulty: Moderate

Keywords: safety stock

40. Safety stock is used to deal with the two most limiting assumptions of the EOQ model.

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.

Difficulty: Moderate

Keywords: purpose of carrying inventory

42. The purpose of finished goods inventory is to uncouple the production function from the purchasing function.

Difficulty: Easy

Keywords: raw materials inventory

43. Work-in-process inventory is higher for complex and lengthy production processes.

Difficulty: Moderate

Keywords: work-in-process inventory

44. The purpose of finished goods inventory is to uncouple the production and sales functions.

Difficulty: Moderate

Keywords: finished goods inventory

45. The purpose of the stock of cash inventory is to uncouple the payment of bills and the collection of accounts due.

Difficulty: Moderate

Keywords: cash stocks

46. The importance of effective inventory management is inversely related to the size of the investment in inventory.

Difficulty: Moderate

Keywords: effective inventory management

47. Long distances between suppliers make the just-in-time inventory control system easy to implement.

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.

Difficulty: Moderate

Keywords: just-in-time inventory system

49. Total quality management (TQM) led to a new inventory management philosophy called single-sourcing.

Difficulty: Moderate

Keywords: total quality management

50. The traditional view of quality allows for some acceptable defect level.

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.

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

Difficulty: Easy

Keywords: spontaneous financing

53. Holding all other variables constant, an increase in _______________ will increase a credit score.

a. total assets

b. working capital

c. earnings before interest and taxes

1. both b and c
2. all of the above

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

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.

Difficulty: Moderate

Keywords: carrying cost

1. 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.

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.

Difficulty: Moderate

Keywords: order point problem

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

1. both b and c
2. all of the above

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.

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.

1. both b and c.
2. all of the above.

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.

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.

Difficulty: Easy

Keywords: aging schedule of accounts receivable

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.

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.

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.

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.

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.

Difficulty: Moderate

Keywords: EOQ model

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.

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.

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

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

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

Difficulty: Moderate

Keywords: EOQ model

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.

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%

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%

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%

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%

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%

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

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%

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%

Difficulty: Moderate

Keywords: effective cost of foregoing trade discount

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

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

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

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

Difficulty: Moderate

Keywords: average inventory

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

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

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

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*.

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

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

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.

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.

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

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

1. Both a and c
2. All of the above

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

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.

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.

Difficulty: Moderate

Keywords: inflation, EOQ model

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

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.

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.

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.

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

Difficulty: Easy

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%.

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.

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.

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

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.

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.

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.

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.

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.

b. $90,000.

c. $100,000.

d. $110,000.

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.

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.

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.

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.

Difficulty: Easy

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

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

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%

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.

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

b. $98,000

c. $103,000

d. $112,000

e. $120,000

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

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

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.

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?

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.

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

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.

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

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 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

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

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

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

Difficulty: Moderate

Keywords: total quality management

Short Answer

132. Discuss the weaknesses of the EOQ model.

Difficulty: Moderate

Keywords: EOQ model, assumptions

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

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?

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?

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?

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

b. Q* = = = 200 boxes

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?

a. Q* = = = 30 sets

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.

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?

a. Q* = )] = 47,673 lbs.

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.)

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?

a. Q* = = = 462 units

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.

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

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.

a. Q* = = = 200

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?

a. Q* = = = 684.11 units

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?

a. Q* = = = = 19 boxes

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?

a. Q* = = = 189 units

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?

a. Q* = = = 9,393 units

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

= (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.

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

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

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