Question 1

The United Shoe Company (USC) does not extend credit to any retail shoe store with a "Fair" or "Limited" Dun and Bradstreet credit rating.As a result of this policy the company loses $36,500,000 in sales each year.Based on prior experience with these types of customers, USC estimates that the average collection period would be 120 days and the bad-debt loss ratio would be 10%.The firm's variable cost ratio is 0.75.USC's required pretax return on receivables investments is 18%.Determine the net change in pretax profits of extending credit to these retail shoe stores.(Assume 365 days per year in any calculations.)

Accepted Answer

Additional sales = $36,500,000
Marginal profitability of additional sales = 0.25 × $36,500,000 = $9,125,000
Additional investment in receivables = ($36,500,000/365) × 120 = $12,000,000
Cost of additional investment in receivables = $12,000,000 × 0.18 = $2,160,000
Additional bad­debt loss = 0.10 × $36,500,000 = $3,650,000
Net change in pretax profits = $9,125,000 - $2,160,000 - $3,650,000 = $3,315,000

Question 2

Whirlwind Company sells to retail appliance stores on credit terms of net 30.Annual credit sales are $182,500,000 spread evenly throughout the year and its accounts average 20 days overdue.The firm's variable cost ratio is 0.70.Determine Whirlwind's average investment in receivables.(Assume 365 days per year an all calculations.)

Accepted Answer

Average collection period = 30 + 20 = 50 days
Average investment in receivables = $182,500,000/365 × 50 = $25,000,000

Question 3

If a lawn mower assembly plant orders 25,000 frames per year at a price of $27 each, what is the EOQ if the ordering cost per order is $35 and the annual inventory carrying cost is 12 percent?

Accepted Answer

Q = [(2)(35)(25,000)/(0.12)(27)]⁰.⁵ = 734.9

Question 4

Haulsee Inc.builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each.Ordering costs are $540 and Haulsee's inventory carrying costs average 14% of the inventory value.What is the EOQ for Hau1see?

Accepted Answer

Q = [(2)(540)(800,000)/(370)(0.14)]⁰·⁵ = 4,084

Question 5

Bluegrass Distilleries, Inc.refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them.This policy results in lost sales of $10 million annually.Based on past experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6 percent.The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20.Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20 percent.When converting from annual to daily data or vice versa, assume there are 365 days per year.If Bluegrass extends full credit to these (previously delinquent) customers, determine the total increase in credit-related costs.

Accepted Answer

Cost of additional receivables investment = $10,000,000/365 × 90 × 0.20 = $493,151
Bad debt losses = 0.06 × $10,000,000 = $600,000
Total costs = $493,151 + $600,000 = $1,093,151

Question 6

Wallace Company sells $73 million of its products to retailers on credit terms of "net 30." Its average collection period is 55 days.To speed up the collection of receivables, the company is considering changing its credit terms to "2/10, net 30." The company expects 40% of its customers to take the cash discount and its average collection period to decline to 35 days.Wallace's required pretax rate of return on receivables investments is 15%.Determine the net effect on Wallace's pretax profits of the change in credit terms.(Assume 365 days per year in any calculations.)

Accepted Answer

Decrease in average receivables balance = ($73,000,000/365) × 55 - ($73,000,000/365) × 35
= $4,000,000
Earnings on funds released by the decrease in receivables = $4,000,000 × 0.15 = $600,000
Cost of cash discount = $73,000,000 × 0.4 × 0.02 = $584,000
Net change in pretax profits = $600,000 - $584,000 = $16,000

Question 7

Bluegrass Distilleries, Inc.refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them.This policy results in lost sales of $10 million annually.Based on past experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6 percent.The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20.Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20 percent.When converting from annual to daily data or vice versa, assume there are 365 days per year.Determine the net effect on Bluegrass Distilleries' pretax profits of extending credit to these (previously delinquent) customers

Accepted Answer

Net Change in Pretax Profits = $10,000,000 × 0.20 - ($10,000,000/365 × 90 × 0.20) -
0.06 × $10,000,000 = $906,849

Question 8

Technico manufactures about 800,000 solar calculators per year.The computer chip used in the calculator cost $4.80 each and the cost of placing an order is $65.If the carrying costs are 16%, what is the EOQ for the chips?

Accepted Answer

Q = [(2)(65)(800,000)/0.768]⁰.⁵ = 11,637

Question 9

Willoughby Industries, Inc.is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them.Current annual credit sales are $10 million on credit terms of "net 30".Such a change in policy is expected to reduce sales by 10 percent, cut the firm's bad-debt losses from 5 to 3 percent, and reduce its average collection period from 72 days to 45 days.The firm's variable cost ratio is 0.70 (profit contribution ratio is 0.30) and its required pretax return (i.e., opportunity cost) on receivables investments is 25 percent.Determine the net effect of this credit tightening policy on the pretax profits of Willoughby.When converting from annual to daily data or vice versa, assume that there are 365 days per year.

Accepted Answer

Reduction in Profit Contribution = $1,000,000 × 0.30 = $300,000
Reduction in A/R = $10,000,000/365 × 72 - $9,000,000/365 × 45 = $863,014
Earnings on Released Funds = $863,014 × 0.25 = $215,753
Decrease in Bad­Debt Losses = $10,000,000 × 0.05 - $9,000,000 × 0.03 = $230,000
Net Change in Pretax Profits = $215,753 + $230,000 - $300,000 = $145,753

Question 10

Accounts receivable consist of the credit of the business.It can take the form of which of the following?

Accepted Answer

I) Trade receivables: These are the receivables arising as a result of the sale of goods or services on credit. They are a significant source of working capital for many businesses.

II) Non-Trade receivables: These are the receivables that arise from non-sales transactions, such as loans to employees or advances to suppliers. They can also include interest, dividends, and rental income receivables.

Therefore, both trade and non-trade receivables form a part of accounts receivable.

Question 11

Haulsee Inc.builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each.Ordering costs are $540 and Haulsee's inventory carrying costs average 14% of the inventory value.What is the total inventory costs?

Accepted Answer

The total inventory cost includes both ordering costs and carrying costs. The carrying cost is calculated as 14% of the inventory value, which is the cost of the motors multiplied by the number of motors. The ordering cost is the cost per order multiplied by the number of orders needed.

Question 12

Tool Mart sells 1,400 electronic water pumps every year.These pumps cost $54.30 each.If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the optimal ordering frequency?

Accepted Answer

T = 197/(1,400/365) = 51.3 or 51 days

Question 13

Cycles de Oro produces 120,000 high-tek bikes a year and orders the brake assembly from IKON for $15.40 each.The order cost is $84 and Cycles estimates their inventory carrying costs are 15%.What is their total ordering cost per year?

Accepted Answer

The answer of Cycles de Oro produces 120,000 high-tek bikes...

Question 14

RCMP has annual credit sales of $37 million.The credit terms are "net 30" and the current average collection period is 45 days.RCMP is considering changing its terms to 1/10, net 30 in an effort to reduce the average collection period.RCMP believes that 35% of its customers will take the discount, reducing the average collection period to 33 days.Should RCMP offer the discount? Assume the firm's required rate of return on its receivables investment is 14%.

Accepted Answer

Reduction is rec. bal. = ($37,000,000/365)(45 - 33) = $1,216,438
Return on reduction = $1,216,438(0.14) = $170,301
Cost of discount = $37,000,000(0.35)(0.01) = $129,500 Net change = $170,301 - $129,500 = $40,801

Question 15

Haulsee Inc.builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each.Ordering costs are $540 and Haulsee's inventory carrying costs average 14% of the inventory value.What is the optimal ordering frequency?

Accepted Answer

The answer of Haulsee Inc.builds 800,000 golf carts a year...

Question 16

Tool Mart sells 1,400 electronic water pumps every year.These pumps cost $54.30 each.If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the firm's EOQ?

Accepted Answer

Q = [(2)(90)(1,400)/(54.30)(0.12)]⁰.⁵ = 196.66 or 197

Question 17

Tool Mart sells 1,400 electronic water pumps every year.These pumps cost $54.30 each.If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the total annual inventory costs?

Accepted Answer

Solution: TC = (1,400/197)90 + (197/2)(54.30)(0.12) = $1,281

Question 18

Covers, Inc.(CI) sells its stainless steel products on terms of "2/10, net 40." CI is considering granting credit to retailers with total assets as low as $500,000.Currently the lowest asset limit is $750,000.CI believes sales will increase $7 million from the new credit group but the average collection period for this new group will be 60 days versus the current average collection period of35 days.If management estimates that 20% of the new customers will take the cash discount but 4% of the new business will be written off as a bad-debt loss, should CI lower its credit standards? Assume Cl's variable cost ratio is 0.7 and its required pretax rate of return on receivables investment is 15%.

Accepted Answer

Profit on new sales= $7,000,000(1 - 0.7) = $2,100,000
Cost of new rec. = ($7,000,000/365)(60)(0.15) = $172,603
Cost new bad debt losses = $7,000,000(0.04) = $280,000
Additional cash discounts= 7,000,000(0.20)(0.02) = $28,000
Net change in pretax profit = $1,619,397

Question 19

When a company measures its marginal costs and marginal returns it is developing:

Accepted Answer

The answer of When a company measures its marginal costs...

Question 20

What is the optimal length of one inventory cycle for a firm that has an economic order quantity of 750 units, average daily demand of 68 units, and a price of $30 per unit?

Accepted Answer

T = 750/68 = 11.03 or 11 days

Quiz 18: The Management of Accounts Receivable and Inventories