Question 1

Viceroy Audio Ltd. produces components for car, home and television stereo systems. The average collection period for receivables has been stable at 32 days and year-end Accounts Receivable at $656,000. With the onset of recession, customers have been slower to pay and the collection period has risen to 42 days. If the cost of capital to Viceroy Audio is 7% and sales are unchanged, what would the expansion of Accounts Receivable cost the company in a year?

Accepted Answer

To calculate the cost of expansion of Accounts Receivable, we need to find out the increase in the average Accounts Receivable balance due to the longer collection period.

The increase in average Accounts Receivable can be calculated as:

Increase in collection period = 42 days - 32 days = 10 days

Increase in Accounts Receivable = (Increase in collection period / Average collection period) x Year-end Accounts Receivable

Increase in Accounts Receivable = (10 / 32) x $656,000 = $205,000

This means that the expansion of Accounts Receivable will cost the company an extra $205,000 in financing costs (assuming a cost of capital of 7%) over the course of a year.

Therefore, the correct answer is C) $14,350.

Question 2

Les Muebles Martineau is considering a credit application from Modulaire Ltee, a well established retailer whose $456,250 worth of purchases from Martineau are expected to provide Martineau with annual EBIT of $56,600 for three years. Modulaire Ltee spreads its orders evenly and would like to be invoiced quarterly with 30 days to pay, resulting in a payment period of 120 days. Martineau has a cost of capital of 9%, and views credit as a capital investment. Factoring in the credit terms, what should be done with Modulaire's application?

Accepted Answer

The NPV calculation shows a negative value of ($6,728), indicating that the credit application does not meet the required return based on Martineau's cost of capital.

Question 3

The average inventory turnover period for Catalina Shoe Stores Ltd. is 26 days against an industry average of 38. Which of the following potential higher costs applies to Catalina?

Accepted Answer

Catalina's faster inventory turnover compared to the industry average suggests they may face higher costs related to being out of stock, as they sell through their inventory more quickly and may struggle to keep up with demand.

Question 4

Magdalene Pottery and Gifts has annual sales revenue of $1,596,875, of which 80% are on credit, and accounts receivable of $143,500. What is the company's average collection period for receivables in days?

Accepted Answer

The average collection period is calculated by dividing accounts receivable by average daily credit sales. First, calculate the annual credit sales: $1,596,875 * 80% = $1,277,500. Then, find the average daily credit sales: $1,277,500 / 365 = $3,500. The average collection period is $143,500 / $3,500 = 41 days.

Question 5

The following accounts have been selected from a company's balance sheet with values in 000's: Accounts payable $205, Inventory $405, Bank Overdraft $143, Land $2,780, Bonds $2,450, and Accounts Receivable $273. What is the amount of working capital available to the company?

Accepted Answer

The answer of The following accounts have been selected from...

Question 6

Sales intelligence indicates that an increase in the company's average collection period from 32 days to 42 days will increase annual sales revenue by 12% from $9,855,000. All sales are on credit. The company's cost of capital is 9%, its cost of goods sold is 60% of revenue and fixed costs are $2,463,000. After consideration for incremental financing costs, how much of an increase in net profit would the company would achieve?

Accepted Answer

The increase in annual sales revenue by 12% from $9,855,000 results in new revenue of $11,037,600 ($9,855,000 * 1.12). The incremental revenue is $1,182,600 ($11,037,600 - $9,855,000). The cost of goods sold (COGS) is 60% of revenue, so the incremental COGS is $709,560 ($1,182,600 * 0.60). The incremental gross profit is $473,040 ($1,182,600 - $709,560). Fixed costs remain unchanged, so the entire incremental gross profit contributes to the incremental net profit before considering the cost of additional financing. The additional financing cost due to the increased collection period is the incremental revenue multiplied by the cost of capital for the additional days (10 days out of 365) which is $29,547 ($1,182,600 * 9% * (10/365)). The incremental net profit after financing costs is $443,493 ($473,040 - $29,547). However, this option is not available, indicating a calculation error in the financing cost step or misunderstanding of the correct approach to calculate the net profit increase. The correct calculation should focus on the net profit increase after all adjustments, including the correct handling of the cost of capital and its application to the incremental revenue or profit, not just the financing cost. Given the options and the mistake in the calculation presented, the correct answer would involve accurately calculating the net profit increase considering both the increase in revenue and the associated costs, including the cost of capital. Without the exact correct calculation presented in the options, the closest correct approach was to calculate the incremental profit before financing costs and then subtract the estimated financing costs, but an error in the calculation or interpretation of the options seems to have occurred.

Question 7

What is the Economic Order Quantity (EOQ)?

Accepted Answer

The Economic Order Quantity (EOQ) is the amount of inventory that should be ordered to minimize the combined costs of ordering and holding inventory. This is achieved by balancing the cost of carrying excess inventory with the cost of placing frequent, smaller orders. Therefore, option A is the correct definition of EOQ.

Question 8

Bowden Building Supply's opening inventory for the year was $810,000 and ending inventory was $625,000 on sales of $6,650,000 and cost of goods sold of $3,600,000. What was Bowden Building Supply's Average Inventory Turnover Period?

Accepted Answer

Average Inventory Turnover Period = (Beginning Inventory + Ending Inventory) / 2 / Cost of Goods Sold / 365

= ($810,000 + $625,000) / 2 / $3,600,000 / 365

= $717,500 / $3,600,000 / 365

= 0.05505 years or 20.11 days

Therefore, the answer is B) 72.8, which is the closest rounded number to the actual answer.

Question 9

Harrison Grocers Ltd., an important customer of J&P Meat Packers, has been paying its invoices in 120 days. If Harrison has a cost of capital of 9.2%, what is the minimum discount level can J&P offer the company to encourage cash on deliver, in other words, immediate cash payment?

Accepted Answer

The answer of Harrison Grocers Ltd., an important customer of...

Question 10

If a company faces a 60-day lead time on orders of a European faucet with an annual demand of 2,190 units, at what inventory level must it reorder to ensure sufficient supply to satisfy average demand?

Accepted Answer

The reorder point is calculated by multiplying the daily demand by the lead time. With an annual demand of 2,190 units, the daily demand is 2,190/365 = 6 units per day. With a 60-day lead time, the reorder point is 6 units/day * 60 days = 360 units.

Question 11

Which of the following will expand working capital?

Accepted Answer

Purchase of inventory for a new store through a bank loan will increase current assets (inventory) and current liabilities (bank loan), thus expanding working capital.

Question 12

Of the five C's of credit, what is considered when attempting to determine a business's capacity to borrow?

Accepted Answer

The answer of Of the five C's of credit, what...

Question 13

BB's Basement, a bargain retail outlet, purchases $4,000 of end of line clothing inventory from J&P Manufacturing and is granted credit terms of 45 days. BB sells out the inventory for $6,000 within two weeks. Proceeds from the sale after salaries, rent and other expenses, but before paying off accounts payable, is $4,500. If BB can make 3% per annum on a 30-day Guaranteed Investment Certificate (GIC), how much did BB make on the jeans and on managing its working capital?

Accepted Answer

BB's profit on the jeans can be calculated by subtracting the cost of inventory purchased ($4,000) from the proceeds of sale ($6,000), which gives $2,000.

BB has a net working capital of $4,500 - $4,000 = $500 after paying off the accounts payable. BB can invest this $500 for 45 days and earn interest. The interest earned can be calculated as follows:

Interest = (3%/365) * ($500) * 45 = $1.23

Therefore, BB's total profit is $2,000 + $1.23 = $511. Option C is the correct answer.

Question 14

Pomico Inc. has $350,000 of receivables on its books as of July 31ˢᵗ, 20% over the month's budget. To assist in determining whether this is due to an increase in credit sales in the month, one or two larger accounts lagging in payment, or a problem with all collections, what should the manager do?

Accepted Answer

Producing an aging schedule of receivables will show how long each customer's payment is overdue, which will help determine if there are one or two larger accounts that are lagging in payment or if there is a problem with all collections. The other options may provide useful information, but they do not directly address the specific issue at hand.

Question 15

A company's accounts payable total $360,960. If the company takes 60 days to pay its outstanding accounts, what is the value of the company's annual credit purchases?

Accepted Answer

The value of the company's annual credit purchases can be calculated by first determining its daily purchases (accounts payable / days to pay = daily purchases) and then multiplying by 365 days. Given accounts payable of $360,960 and a 60-day payment period, the daily purchases are $360,960 / 60 = $6,016. Annual credit purchases are then $6,016 * 365 = $2,195,840.

Question 16

Which of the following typically applies to Just-in-Time (J-I-T) systems?

Accepted Answer

Just-in-Time (J-I-T) systems often involve the supplier bearing the inventory holding costs instead of the manufacturer. This approach reduces the need for the manufacturer to maintain large inventories, thereby saving on storage costs and reducing waste.

Question 17

Miralonge Manufacturing Ltd. has a net profit of $5.3 million on sales for the year of $43.8 million. The cost of goods sold is 40% of revenue and fixed costs totalled $21 million. The company's collection period is 35 days and average inventory turnover period is 75 days. Miralonge has added a new product to its line that is expected to increase sales revenue by 15%. The company's cost of capital is 8% and its ratios of cost of goods to sales, average collection period and average inventory turnover period will stay the same. Fixed costs will remain unchanged. What will be the net increase to profit, including the costs associated with expanding working capital, from the addition to the product line?

Accepted Answer

First, calculate the increase in sales revenue: $43.8 million * 15% = $6.57 million. The cost of goods sold (COGS) is 40% of revenue, so the increase in COGS = $6.57 million * 40% = $2.628 million. The fixed costs remain unchanged, so the gross profit increase from the new product = $6.57 million - $2.628 million = $3.942 million. To calculate the net increase to profit, we must consider the costs associated with expanding working capital. The collection period and inventory turnover period remain the same, indicating that the increase in accounts receivable (A/R) and inventory will be proportional to the increase in sales. Increase in A/R = ($6.57 million / 365 days) * 35 days = $0.631 million. Increase in inventory = ($6.57 million * 40%) / (365 days / 75 days) = $0.432 million. The total increase in working capital = $0.631 million + $0.432 million = $1.063 million. The cost of this increase in working capital = $1.063 million * 8% (cost of capital) = $0.085 million. Therefore, the net increase to profit = $3.942 million - $0.085 million = $3.857 million, which rounds to $3.85 million.

Question 18

Precision Medical Instruments uses 37,500 3-inch polarized mirrors a year. For each case of 25 mirrors, the inventory holding cost is $13.00.The cost of ordering is $8.40. How often should Precision order mirrors per year?

Accepted Answer

The Economic Order Quantity (EOQ) model is used to determine the optimal order quantity that minimizes total inventory costs. The formula for EOQ is given by $\sqrt{\frac{2DS}{H}}$, where $D$ is the annual demand, $S$ is the ordering cost per order, and $H$ is the annual holding cost per unit.Given:- Annual demand ($D$) = 37,500 mirrors- Ordering cost ($S$) = $8.40- Holding cost per case ($H_{case}$) = $13.00- Since each case contains 25 mirrors, the holding cost per mirror ($H$) = $13.00 / 25First, calculate the holding cost per mirror:$H = \frac{13.00}{25} = 0.52$ per mirror per yearThen, calculate the EOQ:$EOQ = \sqrt{\frac{2DS}{H}} = \sqrt{\frac{2 \times 37500 \times 8.40}{0.52}}$$EOQ ≈ \sqrt{\frac{630000}{0.52}} ≈ \sqrt{1211538.46} ≈ 1100.7$ mirrorsTo find how often Precision should order mirrors per year, divide the annual demand by the EOQ:Number of orders per year = $\frac{D}{EOQ} = \frac{37500}{1100.7} ≈ 34.07$Rounding to the nearest whole number gives 34 orders per year. However, the calculation mistake in determining the correct option led to an incorrect conclusion. The correct approach involves calculating the EOQ accurately and then determining the frequency of orders per year based on that EOQ. The mistake was in the interpretation of the EOQ calculation and its application to find the correct answer. The correct process should lead to identifying the number of orders per year that minimizes total costs, which involves correctly applying the EOQ formula and interpreting its result in the context of the problem.

Question 19

Which of the following is an advantage of the ABC system of inventory control?

Accepted Answer

The ABC system of inventory control helps in prioritizing inventory management efforts by focusing on the most valuable items (A items), thus relating the opportunity costs due to poor inventory management to the cost of inventory control.

Question 20

What does the materials requirement planning (MRP) system start with to determine inventory requirements?

Accepted Answer

The MRP system starts with sales forecasts to determine the demand for products, which then helps in planning inventory requirements.

Quiz 12: Managing Working Capital