Chapter 021 Credit and Inventory Management

Transcription

1 Multiple Choice Questions 1. The conditions under which a firm sells its goods and services for cash or credit are called the: A. terms of sale. b. credit analysis. c. collection policy. d. payables policy. e. collection float. SECTION: 21.1 TOPIC: TERMS OF SALE TYPE: DEFINITIONS 2. The process of determining the likelihood that customers will not pay is called: a. the terms of sale. B. credit analysis. c. the collection policy. d. the payables policy. e. disbursement analysis. SECTION: 21.1 TOPIC: CREDIT ANALYSIS TYPE: DEFINITIONS 3. The procedures a firm follows in the pursuit of customer payments are referred to as the firm's policy. a. sales b. credit C. collection d. payables e. disbursements SECTION: 21.1 TOPIC: COLLECTION POLICY TYPE: DEFINITIONS 21-1

2 4. The length of time for which credit is granted to a firm's customers is called the: a. payables period. b. operating cycle. c. transactions period. D. credit period. e. disbursement period. TOPIC: CREDIT PERIOD TYPE: DEFINITIONS 5. The bill for goods or services provided by the seller to the purchaser is called a(n): a. ledger statement. b. warranty. c. indenture. d. indemnity statement. E. invoice. TOPIC: INVOICE TYPE: DEFINITIONS 6. A discount given to buyers as an inducement for prompt payment is called a(n) discount. A. cash b. purchase c. collection d. market e. receivables TOPIC: CASH DISCOUNT TYPE: DEFINITIONS 21-2

3 7. The basic evidence of indebtedness is called the: a. account document. b. sales draft. C. credit instrument. d. commercial paper. e. letter of debt. TOPIC: CREDIT INSTRUMENT TYPE: DEFINITIONS 8. A graphical representation of the sum of the carrying costs and the opportunity costs of a chosen credit policy is called the: a. opportunity cost curve. b. credit extension curve. C. credit cost curve. d. terms of sale graph. e. economic order quantity graph. SECTION: 21.4 TOPIC: CREDIT COST CURVE TYPE: DEFINITIONS 9. A captive finance company is: A. a wholly-owned subsidiary that handles the credit function for the parent firm. b. controlled disbursements company which controls the accounts payables for the parent firm. c. a wholly-owned subsidiary which handles all the long-term debt obligations of the parent firm. d. a loan company which provides financing strictly to a particular industry, such as retail furniture stores. e. a consumer loan company which operates in one clearly defined and limited geographic area. SECTION: 21.4 TOPIC: CAPTIVE FINANCE COMPANY TYPE: DEFINITIONS 21-3

4 10. The basic factors to be evaluated in the credit evaluation process, the five Cs of credit, are: a. conditions, control, cessation, capital, and capacity. b. conditions, character, capital, control, and capacity. c. capital, collateral, control, character, and capacity. d. character, capacity, control, cessation, and collateral. E. character, capacity, capital, collateral, and conditions. SECTION: 21.5 TOPIC: FIVE Cs OF CREDIT TYPE: DEFINITIONS 11. What is the process of quantifying the likelihood of default when granting consumer credit called? A. credit scoring b. credit capacity c. receipts assessment d. conditions for credit e. consumer analysis SECTION: 21.5 TOPIC: CREDIT SCORING TYPE: DEFINITIONS 12. A compilation of a firm's accounts receivables segmented by the length of time each account has remained unpaid is called a(n): a. credit report. B. aging schedule. c. risk assessment report. d. turnover delineation. e. receivables consolidation and consistency report. SECTION: 21.6 TOPIC: AGING SCHEDULE TYPE: DEFINITIONS 21-4

5 13. What is the restocking quantity that minimizes a firm's total inventory cost called? a. short order quantity b. refill unit quantity C. economic order quantity d. minimum stock level e. re-order limit SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY TYPE: DEFINITIONS 14. The procedures used to determine inventory levels for demand-dependent inventory types such as work-in-progress and raw materials are called: a. first-in, first-out methods. b. the Baumol model. c. net working capital planning. d. economic order procedures. E. materials requirements planning. SECTION: 21.8 TOPIC: MATERIALS REQUIREMENTS PLANNING TYPE: DEFINITIONS 15. Which one of the following is a system for managing demand-dependent inventories that minimizes the inventory holdings of a firm? A. just-in-time inventory b. turnover planning c. net working capital planning d. inventory scoring e. inventory ranking SECTION: 21.8 TOPIC: JUST-IN-TIME INVENTORY TYPE: DEFINITIONS 21-5

6 16. The terms of sale generally include which of the following? I. type of credit instrument II. cash discount III. credit period IV. discount period a. I and III only b. II and IV only c. III and IV only d. II, III, and IV only E. I, II, III, and IV SECTION: 21.1 TOPIC: TERMS OF SALE 17. What is the primary purpose of credit analysis? a. determine the optimal credit period b. establish the effectiveness of granting a cash discount c. determine the optimal discount period, if any d. access the frequency and amount of sales by customer E. evaluate whether or not a customer will pay SECTION: 21.1 TOPIC: CREDIT ANALYSIS 18. The period of time which extends from the day a credit sale is made until the bank credits a firm's account with the payment for that sale is known as the period. a. float b. cash collection c. sales D. accounts receivable e. credit SECTION: 21.1 TOPIC: ACCOUNTS RECEIVABLE PERIOD 21-6

7 19. Which one of the following will increase a firm's investment in accounts receivables? a. a decrease in the number of days for which credit is granted b. a decrease in credit sales c. an increase in cash sales d. a decrease in the average collection period E. an increase in average daily credit sales SECTION: 21.1 TOPIC: INVESTMENT IN RECEIVABLES 20. A firm's total investment in receivables depends primarily on the firm's: a. total sales and cash discount period. b. cash to credit sales ratio. c. bad debt ratio. D. average collection period and amount of credit sales. e. amount of credit sales and cash discount percentage. SECTION: 21.1 TOPIC: INVESTMENT IN RECEIVABLES 21. Which one of the following time periods is included in the accounts receivable period but not in the cash collection period? a. the period of time between the receipt of a check and the availability of those funds b. time it takes a firm to process incoming receipts c. period of time a check is in the mail d. the amount of time that it takes a bank to credit a firm's account for a deposit made E. period of time it takes an invoice to reach a customer by mail SECTION: 21.1 TOPIC: INVESTMENT IN RECEIVABLES 21-7

8 22. Which one of the following statements is correct if you purchase an item with credit terms of 1/5, net 15? a. If you pay within 1 day, you will receive a 5 percent discount. B. If you pay within 5 days, you will receive a 1 percent discount. c. If you do not pay within 15 days, you will be charged interest at a 1.5 percent monthly rate. d. If you pay within 15 days, you will receive a 1/5th percent discount. e. You must pay the discounted amount within 15 days. TOPIC: TERMS OF SALE 23. You are doing some comparison shopping. Five stores offer the product you want at basically the same price. Which one of the following stores offers the best credit terms if you plan on taking the discount? a. store A b. store B c. store C d. store D E. store E TOPIC: TERMS OF SALE 21-8

9 24. You are doing some comparison shopping. Five stores offer the product you want at basically the same price. Which one of the following stores offers the best credit terms if you do not plan on taking advantage of the discount? a. store A b. store B c. store C D. store D e. store E TOPIC: TERMS OF SALE 25. Which one of the following statements is correct concerning the credit period? a. The credit period begins when the discount period ends. b. The discount period is the length of time granted to a customer to pay for a purchase. C. The credit period begins on the invoice date. d. With terms of 2/10, net 30, the net credit period is 20 days. e. With EOM dating, all sales are assumed to have occurred on the 15 th of each month. TOPIC: CREDIT PERIOD 21-9

10 26. Which two of the following are the key considerations when setting the length of the credit period for a customer? I. seller's operating cycle II. customer's operating cycle III. seller's inventory period IV. customer's inventory period a. I and II b. II and III c. III and IV D. II and IV e. I and IV TOPIC: CREDIT PERIOD 27. Which one of the following factors tends to favor longer credit periods? a. high consumer demand b. lower priced merchandise c. increased credit risk d. merchandise with low collateral value E. increased competition TOPIC: CREDIT PERIOD 28. Which one of the following statements is correct concerning credit periods? a. Perishable items tend to have longer credit periods. b. Items with low markups tend to have longer credit periods. c. Smaller accounts tend to have longer credit periods. D. A firm may offer different credit terms to different customers. e. Newer products tend to have shorter credit periods. TOPIC: CREDIT PERIOD 21-10

11 29. A cash discount of 3/15, net 45: a. grants customers 45 days to pay after the discount period expires. b. discourages customers from paying early. c. grants free credit for a period of 45 days. d. charges higher prices if a customer pays cash at the time of purchase. E. grants customers 45 days to pay if they forfeit the discount. TOPIC: DISCOUNTS 30. Under credit terms of 2/10, net 25, customers should: a. always pay on the 25 th day. b. take the 10 percent discount and pay immediately. c. take the discount and pay on the 2 nd day. D. either take the discount or pay on the 25 th day. e. both take the discount and pay on the 25 th day. TOPIC: DISCOUNTS 31. A 2/10, net 30 credit policy: A. is an expensive form of short-term credit if a buyer foregoes the discount. b. provides cheap financing to the buyer for 30 days. c. is an inexpensive means of reducing the seller's collection period if everyone takes the discount. d. tends to have little effect on the seller's collection period due to the high effective interest rate. e. tends to increase a firm's investment in receivables as compared to a straight net 30 policy. TOPIC: COST OF CREDIT 21-11

12 32. Tressler's offers trade discount with terms of 2/5, EOM. When are invoices with these terms due? a. Invoices are due on the last day of the month in which the purchase occurred. b. Invoices are due on the last day of the month following the month of purchase. c. Invoices are due five days after the purchase date. D. Invoices are due on the 5 th of the month following the month of purchase. e. Invoices are due on the 5 th of the month following the month of purchase if you want the discount, otherwise, the invoices are due at the end of the month following the month of purchase. TOPIC: TRADE DISCOUNT 33. Which one of the following credit instruments is commonly used in international commerce? a. open account b. sight draft c. time draft D. banker's acceptance e. promissory note TOPIC: CREDIT INSTRUMENTS 34. A conditional sales contract: a. passes title to the goods sold to the buyer at the time the contract is signed. b. normally calls for one lump sum payment on the contract payment date. C. generally has a built in interest cost. d. is payable immediately upon receipt. e. is a formal bid for a project. TOPIC: CREDIT INSTRUMENTS 21-12

13 35. Which of the following statements correctly reflect the effects of granting credit to customers? I. Total revenues may increase if both the quantity sold and the price per unit increase when credit is granted. II. A firm's cash cycle generally increases if credit is granted, all else equal. III. Both the cost of default and the cost of discounts must be considered before granting credit. IV. A firm may have to increase its borrowing if it decides to grant credit to its customers. a. I, II, and III only b. II, III, and IV only c. I, III, and IV only d. I, II, and IV only E. I, II, III, and IV SECTION: 21.3 TOPIC: CREDIT POLICY EFFECTS 36. You are considering switching from an all cash credit policy to a net 30 credit policy. You do not expect the switch to affect either your sales quantity or your sales price. Ignoring interest and assuming that every month has 30 days, your net present value of the switch will be equal to: a. zero. b. your selling price per unit. c. your selling price per unit multiplied by -1. d. your selling price per unit multiplied by -30. E. your total monthly sales multiplied by -1. SECTION: 21.3 TOPIC: EVALUATING CREDIT POLICY 21-13

14 37. The optimal amount of credit would equate the incremental costs of carrying the increase in accounts receivable to the incremental: a. decrease in the cash cycle. b. benefit from decreasing the inventory level. C. cash flows from increased sales. d. increase in bad debts. e. gain in net profits. SECTION: 21.4 TOPIC: OPTIMAL AMOUNT OF CREDIT 38. When credit policy is at the optimal point, the: a. total costs of granting credit will be maximized. b. carrying costs of credit will be equal to zero. c. opportunity cost of credit will be equal to zero. D. carrying costs will equal the opportunity costs. e. total costs will equal the opportunity costs. SECTION: 21.4 TOPIC: OPTIMAL CREDIT POLICY 39. If you extend credit to a one-time new customer you risk an amount equal to: a. the sales price of the item sold. B. the variable cost of the item sold. c. the fixed cost of the item sold. d. the profit margin on the item sold. e. zero. SECTION: 21.5 TOPIC: CREDIT ANALYSIS 21-14

15 40. Which one of the following statements is correct? a. If the majority of your new customers become repeat customers then there is a strong argument against extending credit even if the default rate is low. b. A customer's past payment history is not indicative of their future payment history. C. A suggested policy for offering credit to new customers is to limit the amount of their initial credit purchase. d. The risk of issuing credit is the same for a new customer as it is for an existing customer. e. The recommended credit policy for new customers is to extend the maximum amount you are willing to ever extend to that customer as their initial credit limit. SECTION: 21.5 TOPIC: CREDIT ANALYSIS 41. Which of the following are frequently used as sources of information when trying to ascertain the creditworthiness of a customer? I. payment history with similar firms II. credit reports III. financial statements IV. information provided by a bank a. I and III only b. II and IV only c. I and II only d. I, II, and III only E. I, II, III, and IV SECTION: 21.5 TOPIC: CREDIT INFORMATION 42. When evaluating the creditworthiness of a customer, the term character refers to the: a. nature of the cash flows of the customer's business. b. customer's financial resources. c. types of assets the customer wants to pledge as collateral. D. customer's willingness to pay bills in a timely fashion. e. nature of the customer's line of work. SECTION: 21.5 TOPIC: FIVE Cs OF CREDIT 21-15

16 43. Which one of the five Cs of credit refers to a firm's financial reserves? a. character b. capacity c. collateral d. conditions E. capital SECTION: 21.5 TOPIC: FIVE Cs OF CREDIT 44. Which one of the five Cs of credit refers to the general economic situation in the customer's line of business? a. capacity b. character C. conditions d. capital e. collateral SECTION: 21.5 TOPIC: FIVE Cs OF CREDIT 45. Which one of the following statements is correct? A. An aging schedule helps identify which customers are the most delinquent. b. The percentage of total receivables that fall within a certain time period on an aging schedule will remain constant over time even if the firm has seasonal sales. c. Normally firms call their delinquent customers prior to sending them a past due letter. d. A constant average collection period over a period of time is cause for concern. e. It is common practice when a customer files for bankruptcy to sell that customer's receivable at face value. SECTION: 21.6 TOPIC: COLLECTION POLICY 21-16

17 46. Which one of the following inventory items is probably the least liquid? a. bricks held in inventory by a home builder b. a garden tractor held in inventory by a home improvements retail outlet C. a partially assembled motor for a tractor d. cut logs owned by a timber mill e. satellite radio systems held in inventory by a car manufacturer SECTION: 21.7 TOPIC: INVENTORY TYPES 47. Which one of the following inventory items is probably the most liquid? a. a custom made set of kitchen cabinets b. metal cabinets for dishwashers C. corn held in a storage facility d. customized drilling press e. a partially built new home SECTION: 21.7 TOPIC: INVENTORY TYPES 48. Which one of the following inventory-related costs is considered a shortage cost? a. storage costs b. insurance cost C. cost of safety reserves d. obsolescence cost e. opportunity cost of capital used for inventory purchases SECTION: 21.7 TOPIC: INVENTORY COSTS 21-17

18 49. The ABC approach to inventory management is based on the concept that: a. inventory should arrive just in time to be used. b. the inventory period should be constant for all inventory items. c. basic inventory items that are essential to production and also inexpensive should be ordered in small quantities only. D. a small percentage of the inventory items probably represents a large percentage of the inventory cost. e. one-third of a year's inventory need should be on hand, another third should be on order, and the last third should not be ordered yet. SECTION: 21.8 TOPIC: INVENTORY MANAGEMENT TECHNIQUES 50. The economic order quantity model is designed to determine how much: a. total inventory a firm needs in any one year. b. total inventory costs will be for any one year. C. inventory should be purchased at a time. d. inventory will be sold per day. e. a firm loses in sales per day when an inventory item is depleted. SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 51. At the optimal order quantity size, the: a. total cost of holding inventory is fully offset by the restocking costs. b. carrying costs are equal to zero. c. restocking costs are equal to zero. d. the total costs equal the carrying costs. E. the carrying costs equal the restocking costs. SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 21-18

19 52. The economic order quantity model is designed to minimize: a. production costs. b. inventory obsolescence. c. the carrying costs of inventory. d. the costs of replenishing inventory. E. the total costs of holding inventory. SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 53. Which one of the following items is most likely a derived-demand inventory item? a. cereal ready to be bagged and shipped to stores B. steering wheels used by an auto manufacturer c. shoes on display in a retail store d. toys ready to be shipped to toy stores e. wheat harvested by a farmer SECTION: 21.8 TOPIC: DERIVED-DEMAND INVENTORY 54. Inventory needs under a derived-demand inventory system are: a. primarily dependent upon the competitive demands placed on a firm's suppliers. B. based on the anticipated demand for the finished product. c. based on minimizing the cost of restocking inventory. d. held constant over time. e. determined by a kanban system. SECTION: 21.8 TOPIC: DERIVED-DEMAND INVENTORY 21-19

20 55. A just-in-time inventory system: I. when implemented properly reduces the cost of inventory to zero. II. increases the inventory turnover rate. III. is sufficient to handle immediate production needs. IV. minimizes the costs of holding inventory. a. I and III only b. II and IV only c. I, II, and IV only D. II, III, and IV only e. I, II, III, and IV SECTION: 21.8 TOPIC: JUST-IN-TIME INVENTORY 56. The incremental investment in receivables under the accounts receivable approach is equal to: a. b. C. d. e. SECTION: 21.A TOPIC: ACCOUNTS RECEIVABLE APPROACH 57. The accounts receivable approach supports the theory that: A. your risk of offering credit to a new customer is limited to your cost of the items sold. b. the best credit policy is an all-cash policy. c. the cost of offering credit to a new customer is the same as the cost of offering credit to an existing customer. d. foregoing cash discounts is a method of obtaining inexpensive short-term financing. e. the default risk of a credit policy is the same as the default risk under an all cash-policy if your customers remain the same. SECTION: 21.A TOPIC: ACCOUNTS RECEIVABLE APPROACH 21-20

21 58. Which two of the following are the key elements in determining whether or not a switch from a no-credit policy to a credit policy is advisable? I. variable cost per unit II. cash discount percentage III. credit price IV. default rate a. I and III only B. II and IV only c. II and III only d. I, II, and IV only e. II, III, and IV only SECTION: 21.A TOPIC: NPV OF SWITCH 59. On average your firm sells $26,500 of items on credit each day. Your average operating cycle is 51 days and your firm acquires and sells inventory on average every 19 days. What is your average accounts receivable balance? a. $503,500 B. $848,000 c. $1,012,500 d. $1,315,500 e. $1,855,000 Accounts receivable balance = $26,500 (51 19) = $848,000 SECTION: 21.1 TOPIC: ACCOUNTS RECEIVABLE BALANCE 21-21

22 60. You just purchased $8,700 of goods from your supplier with credit terms of 3/10, net 30. What is the discounted price? a. $6,090 b. $6,960 c. $7,830 D. $8,439 e. $8,911 Discounted price = $8,700 (1.03) = $8,439 TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS 61. Today, August 5, Solomon, Inc. bought $22,000 worth of merchandise from a supplier. The credit terms are 2/8, net 25. By what day does Solomon, Inc. have to make the payment to receive the discount? a. August 7 B. August 13 c. August 22 d. August 28 e. August 30 End of discount period = August days = August 13 TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS 21-22

23 62. Your supplier grants you credit terms of 2/10, net 35. What is the effective annual rate of the discount if you purchase $2,900 worth of merchandise? a percent b percent c percent d percent E percent Days in period = = 25; Periods per year = 365 / 25 = 14.6; Interest rate for 30 days = [.02 $2,900] / [(1.02) $2,900] = $58 / $2,842 =.02041; Effective annual rate = ( ) =.3431 = 34.3 percent TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS 63. Your firm currently sells 500 units a month at a price of $75 a unit. You think you can increase your sales by an additional 130 units if you switch to a net 30 credit policy. The monthly interest rate is.4 percent and your variable cost per unit is $35. What is the incremental cash inflow from the proposed credit policy switch? a. $1,800 b. $2,400 c. $3,600 D. $5,200 e. $6,000 Incremental cash flow = ($75 $35) 130 = $5,200 SECTION: 21.3 TOPIC: CREDIT POLICY SWITCH 21-23

24 64. Your firm currently sells 215 units a month at a price of $90 a unit. You think you can increase your sales by an additional 45 units if you switch to a net 30 credit policy. The monthly interest rate is.5 percent and your variable cost per unit is $60. What is the net present value of the proposed credit policy switch? A. $247,950 b. $250,650 c. $255,050 d. $267,300 e. $274,350 NPV = -[($90 215) + ($60 45)] + [($90 - $60) 45] /.005 = $247,950 SECTION: 21.3 TOPIC: CREDIT POLICY SWITCH 65. Currently, your firm sells 170 units a month at a price of $140 a unit. You think you can increase your sales by an additional 30 units if you switch to a net 30 credit policy. The monthly interest rate is.6 percent and your variable cost per unit is $100. What is the net present value of the proposed credit policy switch? A. $173,200 b. $187,200 c. $190,200 d. $197,000 e. $200,000 NPV = -[($ ) + ($100 30)] + [($140 $100) 30] /.006 = $173,200 SECTION: 21.3 TOPIC: CREDIT POLICY SWITCH 21-24

25 66. Currently, Tyler Enterprises sells 350 units a month at a price of $42 a unit. The company thinks they can increase sales by an additional 100 units if they switch to a net 30 credit policy. The monthly interest rate is.4 percent and the variable cost per unit is $22. What is the incremental cash inflow of the proposed credit policy switch? a. $1,480 B. $2,000 c. $2,200 d. $2,520 e. $4,200 Incremental cash flow = ($42 $22) 100 = $2,000 SECTION: 21.3 TOPIC: CREDIT POLICY SWITCH 67. Your company currently sells a product with a variable cost per unit of $16 and a unit selling price of $31. At the present time, your company only sells on a cash basis and has monthly sales of 310 units. The monthly interest rate is 2 percent. Your company is considering switching to a net 30 credit policy. What is the switch break-even point? a. 312 units b. 316 units c. 320 units D. 323 units e. 329 units Switch break-even point = Q 310 = ($31 310) / {[($31 $16) /.02] $16} = = 13 units; Q = = 323 units SECTION: 21.3 TOPIC: SWITCH BREAK-EVEN POINT 21-25

26 68. The Gardeners Co. currently sells 1,800 units a month for total monthly sales of $79,200. The company is considering replacing its current cash only credit policy with a net 30 policy. The variable cost per unit is $34 and the monthly interest rate is 1.7 percent. What is the switch break-even level of sales? A. 1,943 units b. 2,017 units c. 2,108 units d. 2,406 units e. 2,548 units Switch break-even point = Q 1,800 = ($79,200) / {[(($79,200 / 1,800) - $34) /.017] - $34} = = 143 units; Q = ,800 = 1,943 units SECTION: 21.3 TOPIC: SWITCH BREAK-EVEN POINT 69. Stamford, Inc. currently sells 8,350 units a month for total monthly sales of $179,500. The company is considering replacing its current cash only credit policy with a net 30 policy. The variable cost per unit is $6.23 and the monthly interest rate is 2 percent. What is the switch break-even level of sales? a. 8,416 units b. 8,517 units C. 8,587 units d. 8,606 units e. 8,686 units Switch break-even point = Q 8,350 = ($179,500) / {[(($179,500 / 8,350) - $6.23) /.02] - $6.23} = = 237 units; Q = ,350 = 8,587 units SECTION: 21.3 TOPIC: SWITCH BREAK-EVEN POINT 21-26

27 70. You have the opportunity to make a one-time sale if you will give a new customer 30 days to pay. You suspect there is a 20 percent chance this person will never pay you. The sales price of the item the customer wants to buy is $136. Your variable cost on that item is $94 and your monthly interest rate is 2.5 percent. Should you grant credit to this customer? Why or why not? A. yes; because the net present value of the potential sale is $12 b. yes; because the net present value of the potential sale is $39 c. no; because the net present value of the potential sale is -$44 d. no; because the net present value of the potential sale is -$2 e. doesn't matter; because the NPV of the potential sale is zero NPV = -$94 + (1 -.20) [$136 / ( )] = $12.15 = $12 SECTION: 21.5 TOPIC: ONE-TIME SALE 71. You are considering a temporary opening of a kiosk in the local mall. Any sale you make will be a one-time sale. There is only a 45 percent chance that you will collect your money on a credit sale. The product you want to sell has a variable cost of $4.10 and a sales price of $5.75. The monthly interest rate is 1.3 percent. Should you offer people 30 days to pay? Why or why not? a. yes; because you will earn $2.23 on every credit sale you make b. yes; because you will earn $5.68 on every credit sale you make c. no; because the net present value of the potential sale is -$1.55 D. no; because the net present value of the potential sale is -$.98 e. it doesn't matter; because the present value of the potential sale is $0 NPV = -$ (1.45) [$5.75 / ( )] = -$.98 SECTION: 21.5 TOPIC: ONE-TIME SALE 21-27

28 72. You are trying to attract new customers that you feel could become repeat customers. The average price of the items you sell is $93 with a $70 variable cost. Your monthly interest rate is 2.1 percent. Your experience tells you that 10 percent of these customers will never pay their bill. What is the value of a new customer who does not default on their bill? a. $986 B. $1,095 c. $2,617 d. $3,333 e. $4,429 PV = ($93 $70) /.021 = $1, = $1,095 SECTION: 21.5 TOPIC: REPEAT SALE 73. You are trying to attract new customers that you feel could become repeat customers. The average price of the items you sell is $93 with a $70 variable cost. Your monthly interest rate is 2.1 percent. Your experience tells you that 10 percent of these customers will never pay their bill. Should you offer credit terms of net 30 to attract these potential customers? Why or why not? a. yes; because the net present value of extending credit is $40 B. yes; because the net present value of extending credit is $916 c. no; because the net present value of extending credit is -$1,025 d. no; because the net present value of extending credit is -$59 e. it doesn't matter; because the present value of extending credit is $0 NPV = -$70 + (1.10) [($93 $70) /.021] = $ = $916 SECTION: 21.5 TOPIC: REPEAT SALE 21-28

29 74. You sell 7,000 units of an item each year. The carrying cost per unit is $1.10 and the fixed costs per order are $75. What is the economic order quantity? a. 691 units b. 713 units c. 859 units D. 977 units e. 1,025 units EOQ = (2 7,000 $75) / $1.10 = 954, = = 977 units SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 75. The most fashionable pair of roller skates sells for $45.99 a pair. Your store consistently sells 8,500 pairs of these roller skates year after year. The fixed costs to order more of this item is $70 and the carrying costs are $2.80 per pair. What is the economic order quantity? a. 184 units b. 309 units c. 461 units d. 525 units E. 652 units EOQ = (2 8,500 $70) / $2.80 = 425,000 = = 652 units SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 21-29

30 76. One of the best selling items your firm offers sells for $19.99 a unit. The variable cost per unit is $11.59 and the carrying cost per unit is $.58. You sell 10,415 of these units each year. The fixed cost to order this item is $65. What is the economic order quantity? a. 1,080 units b. 1,314 units C. 1,528 units d. 1,773 units e. 1,946 units EOQ = (2 10,415 $65) / $.58 = 2,334, = 1, = 1,528 units SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 77. Each year you sell 1,200 units of a product at a price of $59.99 each. The variable cost per unit is $37.91 and the carrying cost per unit is $4.57. You have been buying 175 units at a time. Your fixed cost of ordering is $80. What is the economic order quantity? a. 185 units b. 195 units C. 205 units d. 215 units e. 225 units EOQ = (2 1,200 $80) / $4.57 = 42, = = 205 units SECTION: 21.8 TOPIC: ECONOMIC ORDER QUANTITY (EOQ) 21-30

31 78. Your firm currently has a cash sales only policy. Under this policy, you sell 290 units a month at a price of $160 a unit. Your variable cost per unit is $104 and your carrying cost per unit is $2.70. The monthly interest rate is 1.1 percent. You think that you can increase your sales to 350 units a month if you institute a net 30 credit policy. What is the net present value of the switch using the one-shot approach? a. $228,400 b. $248,709 C. $252,814 d. $282,233 e. $285,902 Monthly benefit = [($ ) / 1.011] ($ ) [($160 $104) 290] = $55, $36,400 $16,240 = $2,750.70; NPV of switch = $2, ($2, /.011) = $252,814 SECTION: 21.A TOPIC: ONE-SHOT APPROACH 79. Under your current cash sales only policy you sell 170 units a month at a price of $25. Your variable cost per unit is $18 and your monthly interest rate is 2 percent. Based on a recent survey, you believe that you can sell an additional 40 units per month if you offer a net 30 credit policy. What is the net present value of the switch using the one-shot approach? a. $5,044 b. $6,970 c. $7,584 d. $8,853 E. $9,030 Monthly benefit = [($25 ( )) / 1.02] ($18 ( )) [($25 $18) 170] = $5, $3,780 $1,190 = $177.06; NPV of switch = $ ($ /.02) = $9,030 SECTION: 21.A TOPIC: ONE-SHOT APPROACH 21-31

32 80. Under your current cash sales only policy you sell 110 units a month for a total sales value of $7,590. Your variable cost per unit is $38 and your monthly interest rate is 1.7 percent. Based on a recent survey, you believe that you can sell an additional 30 units per month if you offer a net 30 credit policy. What is the net present value of the proposed switch using the accounts receivable approach? A. $45,976 b. $47,116 c. $49,081 d. $50,224 e. $53,566 SECTION: 21.A TOPIC: ACCOUNTS RECEIVABLE APPROACH 81. You are currently selling 60 units a month at a price of $195 a unit. Your variable cost of each unit is $145. If you switch from your current cash sales only policy to a net 30 policy you think your sales will increase to a total of 100 units per month. Your monthly interest rate is 1.5 percent. What is the net present value of this proposed switch using the accounts receivable approach? A. $115,833 b. $126,667 c. $133,333 d. $145,667 e. $152,833 SECTION: 21.A TOPIC: ACCOUNTS RECEIVALBE APPROACH 21-32

33 82. Your current sales consist of 25 units per month at a price of $200 a unit. You are weighing the pros and cons of switching to a net 30 credit policy from your current cash only policy. If you decide to switch your credit policy you also plan to increase the sales price to $215 a unit. If you make the switch you do not expect your total monthly sales quantity to change but you do expect a 2 percent default rate. The monthly interest rate is 2.5 percent. What is the net present value of the proposed credit policy switch? a. $0 b. $5,000 C. $5,700 d. $10,000 e. $10,700 d = ($215 - $200) / $215 = NPV = -($200 25) + {($215 25) [( ) /.025]} = -$5,000 + $10,700 = $5,700 SECTION: 21.A TOPIC: DISCOUNTS AND DEFAULT RISK 83. Your current sales consist of 25 units per month at a price of $200 a unit. You are weighing the pros and cons of switching to a net 30 credit policy from your current cash only policy. If you decide to switch your credit policy you also plan to increase the sales price to $215 a unit. The monthly interest rate is 2 percent. What is the break-even default rate of the proposed switch? a percent b percent c percent d percent E percent d = ($215 $200) / $215 = ; = ( ) = = 5.12 percent SECTION: 21.A TOPIC: DISCOUNTS AND DEFAULT RISK 21-33

34 Essay Questions 84. Which do you feel is the more appropriate upper limit for the credit period which a seller offers to a buyer: the buyer's operating cycle or the buyer's inventory period? The operating cycle is the sum of the inventory and accounts receivable periods. The inventory period is probably the better target as an upper limit for the seller's credit period since it is questionable whether or not the seller should be financing the buyer's receivables. The credit period should definitely not exceed the buyer's operating period as the seller would then be financing all of the buyer's inventory and accounts receivables, plus other aspects of the buyer's operations. AACSB TOPIC: REFLECTIVE THINKING TOPIC: LENGTH OF CREDIT PERIOD 85. Assume all suppliers to a large retail chain offer credit terms of 2/10, net 30. The retail chain consistently takes the 2 percent discount and pays in 60 days. When pressed on the issue, the retail chain tells the suppliers they can either accept the payments as they currently are or lose the business. Is this ethical? How might this impact a small supplier versus a large supplier? Explain. This question can lead to a lively discussion about the ethics of abusing the credit period. Some students will argue that it is unethical for the large firm to exercise its will against its suppliers. Most would argue that a supplier that is also a relatively large firm will better be able to negotiate with the retail chain and work out a more favorable arrangement than the current situation. If a supplier is small, this account may be a significant proportion of the supplier's total sales. In that case, the supplier may have no choice other than accepting the terms as dictated by the retail chain or going out of business. Whether or not the actions of the retail chain are ethical or not is debatable, but this practice occurs fairly frequently. AACSB TOPIC: REFLECTIVE THINKING AND ETHICS TOPIC: ETHICS AND THE CREDIT PERIOD 21-34

35 86. Why might firms forego discounts even though it is costly to do so? What steps might a firm pursue to be able to take these discounts? Firms will forego discounts when they have inadequate cash flow to take them. It would be difficult to argue that this type of financing, given the typically high cost of foregoing the discount, would be cheaper than other sources available to the firm. However, it might be more desirable than raising cash, say through secured inventory financing or factoring receivables. As far as correcting the problem, any of the cash and liquidity management policies discussed earlier in the text would help the situation if the firm is able to enhance its liquidity and cash flow. AACSB TOPIC: REFLECTIVE THINKING TOPIC: DISCOUNTS 87. All else equal, it is likely that firms with (1) excess capacity, (2) low variable costs, and (3) repeat customers will extend credit more liberally than others. Why? Firms with excess capacity will likely extend credit more liberally as a means to increase sales and capacity usage. Firms with low variable costs extend credit more liberally as the cost to do so is limited to the variable cost of the items sold. Finally, firms with repeat customers gain familiarity with their customers' character and credit needs, thereby facilitating more liberal credit terms. AACSB TOPIC: REFLECTIVE THINKING SECTION: 21.4 TOPIC: LIBERAL CREDIT TERMS 21-35