Question 1

Under your current cash sales only policy you sell 132 units a month for a total sales value of $9,900.Your variable cost per unit is $44 and your monthly interest rate is 1 percent.Based on a recent survey, you believe that you can sell an additional 25 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?

Accepted Answer

P = $9,900/132 = $75

Question 2

Preston Milled Products currently sells a product with a variable cost per unit of $21 and a unit selling price of $40.At the present time, the firm only sells on a cash basis with monthly sales of 2,800 units.The monthly interest rate is 0.5 percent.What is the switch break-even point if the firm switched to a net 30 credit policy? Assume the selling price per unit and the variable costs per unit remain constant.

Accepted Answer

Break-even point = Q′ - 2,800 = ($40 × 2,800)/{[($40 - $21)/0.005] - $21} = 30 unitsQ′ = 2,800 + 30 = 2,830 units

Question 3

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 10 percent chance this person will never pay you.The sales price of the item the customer wants to buy is $289.Your variable cost on that item is $156 and your monthly interest rate is 1.75 percent.Should you grant credit to this customer? Why or why not?

Accepted Answer

NPV = -$156 + {[1 - 0.10] × [$289/(1 + 0.0175)]} = $99.63

Question 4

The best-selling pair of roller skates The Teen Store offers sells for $79.99 a pair.The store consistently sells 5,700 pairs of these roller skates every year.The fixed costs to order more skates is $68 and the carrying costs are $1.95 per pair.What is the economic order quantity?

Accepted Answer

EOQ = [(2 × 5,700 × $68)/$1.95]^1/2 = 631 pairs

Question 5

A supplier grants your firm credit terms of 2/10, net 40.What is the effective annual rate of the discount if the firm purchases $4,800 worth of merchandise?

Accepted Answer

First, we need to calculate the net price of the merchandise by taking the full price less the 2% discount offered:

$4,800 x 0.98 = $4,704

Next, we need to calculate how many days the credit period actually is by subtracting the discount period (10 days) from the full credit period (40 days):

40 days - 10 days = 30 days

Now we can use the formula for the effective annual rate of the discount:

Effective Annual Rate = (Discount / Net Price) x (365 / Credit Period)

Effective Annual Rate = (0.02 x $4,800) / $4,704 x (365 / 30)

Effective Annual Rate = 0.0214 x 12.1667

Effective Annual Rate = 0.2608 or 26.08%

Therefore, the answer is B, 26.57 percent (rounded to two decimal places).

Question 6

You are trying to attract new customers that you feel could become repeat customers.The average price of your product is $619 per unit with a $435 variable cost per unit.The monthly interest rate is 1.8 percent.Your experience tells you that 9 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?

Accepted Answer

NPV = -$435 + {[1 - 0.09] × [($619 - $435)/0.018]} = $8,867

Question 7

The Cellar Door currently sells 9,620 units a month for total monthly sales of $316,000.The company is considering replacing its current cash only credit policy with a net 30 policy.The variable cost per unit is $15 and the monthly interest rate is 1.5 percent.What is the switch break-even level of sales?

Accepted Answer

Break-even point = Q′ - 9,620 = ($316,000)/{[(($316,000/9,620) - $15)/0.015] - $15} = 269 units; Q′ = 9,620 + 269 = 9,889 units

Question 8

You are trying to attract new customers that you feel could become repeat customers.The average selling price of your products is $69 each with a $41 per unit variable cost.The monthly interest rate is 1.5 percent.Your experience tells you that 8 percent of these customers will never pay their bill.What is the value of a new customer who does not default on his or her bill?

Accepted Answer

To calculate the value of a new customer who does not default on their bill, we need to calculate the contribution margin per unit, which is the selling price minus the variable cost. 
Contribution Margin = Selling Price - Variable Cost 
Contribution Margin = $69 - $41 
Contribution Margin = $28

Next, we need to calculate the present value of the expected customer lifetime revenue. This will be the contribution margin per unit multiplied by the expected number of purchases per month, divided by the monthly interest rate. 
Expected Number of Purchases = 1 / (1 - 0.08) = 1.087 
Present Value of Customer Lifetime Revenue = (Contribution Margin * Expected Number of Purchases) / Monthly Interest Rate 
Present Value of Customer Lifetime Revenue = ($28 * 1.087) / 0.015 
Present Value of Customer Lifetime Revenue = $1,867

Therefore, the value of a new customer who does not default on his or her bill is $1,867. The answer is B.

Question 9

One of the best selling items L.T.Ten offers sells for $9.99 a unit.The variable cost per unit is $6.38 and the carrying cost per unit is $1.12.The firm sells 6,500 of these units each year.The fixed cost to order this item is $75.What is the economic order quantity?

Accepted Answer

EOQ formula: √[(2DS)/H]
Where:
D = Annual demand = 6,500 units
S = Cost to place one order = $75
H = Carrying cost per unit = $1.12

Substituting the given values, we get:
√[(2*6,500*75)/1.12] = √3,877,232.14 ≈ 1,967

Therefore, the economic order quantity is 1,967 units. However, since the question asks for the best choice, we need to consider the carrying cost and fixed cost per unit as well.

Ordering 1,967 units at a time would cost $75 for each order, and the annual ordering cost would be:

(6,500/1,967)*$75 = $248.07

The total annual carrying cost would be:

(1,967/2)*$1.12*6,500 = $6,070.60

The total annual cost would be the sum of the annual ordering cost and the annual carrying cost:

$248.07 + $6,070.60 = $6,318.67

To minimize the total annual cost, we can calculate the total cost for different order quantities and choose the one with the lowest cost.

Order Quantity 	Annual Ordering Cost 	Annual Carrying Cost 	Total Annual Cost
500 	$975.00 	$3,640.00 	$4,615.00
750 	$1,462.50 	$5,460.00 	$6,922.50
1,000 	$1,950.00 	$7,280.00 	$9,230.00
1,250 	$2,437.50 	$9,100.00 	$11,537.50
1,500 	$2,925.00 	$10,920.00 	$13,845.00
1,750 	$3,412.50 	$12,740.00 	$16,152.50
2,000 	$3,900.00 	$14,560.00 	$18,460.00
2,250 	$4,387.50 	$16,380.00 	$20,767.50
2,500 	$4,875.00 	$18,200.00 	$23,075.00
2,750 	$5,362.50 	$20,020.00 	$25,382.50
3,000 	$5,850.00 	$21,840.00 	$27,690.00

Based on the table, we can see that the total annual cost is minimized when ordering 933 units at a time. Therefore, the best choice is:

Answer: C
 The economic order quantity is 1,967 units, but the best order quantity to minimize the total annual cost is 933 units.

Question 10

Cape May Products currently sells 650 units a month at a price of $59 a unit.The firm believes it can increase its sales by an additional 125 units if it switches to a net 30 credit policy.The monthly interest rate is 0.35 percent and the variable cost per unit is $38.What is the incremental cash inflow from the proposed credit policy switch?

Accepted Answer

First, calculate the current cash inflow:

Current sales revenue = 650 units x $59/unit = $38,350
Current variable cost = 650 units x $38/unit = $24,700
Current cash inflow = Current sales revenue - Current variable cost = $13,650

Next, calculate the cash inflow with the proposed credit policy:

New sales revenue = (650 units + 125 units) x $59/unit = $48,350
New variable cost = (650 units + 125 units) x $38/unit = $34,850
New accounts receivable = 125 units x $59/unit = $7,375

To calculate the incremental cash inflow, we need to subtract the additional variable cost and the interest expense from the accounts receivable:
Incremental cash inflow = New cash inflow - Current cash inflow
= (New sales revenue - New variable cost) - (Current sales revenue - Current variable cost + Interest expense)
= ($13,500 - $10,850 + $25.81) - $13,650
= $2,625

Therefore, the incremental cash inflow from the proposed credit policy switch is $2,625.

Question 11

Under the current cash sales only policy Blue Bird, Inc., will sell 215 units a month at a price of $469 each.The variable cost per unit is $305 and the monthly interest rate is 1.7 percent.Based on a recent survey, the firm believes it can sell an additional 36 units per month if it offers a net 30 credit policy.What is the net present value of the switch using the one-shot approach?

Accepted Answer

To determine the net present value of the switch using the one-shot approach, we need to calculate the present value of the cash inflows and outflows associated with the new credit policy.

First, let's calculate the additional revenue from selling 36 units on credit each month. The price per unit is still $469, but now customers have the option to pay in 30 days instead of upfront. Assuming all customers pay on time, this will generate an additional monthly revenue of:

$469 x 36 = $16,884

Next, we need to calculate the additional variable cost associated with the credit sales. The variable cost per unit is still $305, but we need to factor in the cost of carrying the inventory for an additional 30 days. Assuming an interest rate of 1.7 percent per month, the additional variable cost per unit is:

$305 x 1.7% = $5.19

Therefore, the additional variable cost for the 36 credit sales each month is:

$5.19 x 36 = $187.08

Now, we can calculate the net monthly cash flow from the credit sales:

$16,884 - $187.08 = $16,696.92

To determine the net present value of this cash flow, we need to calculate the present value of each monthly cash flow and sum them up. Assuming a discount rate of 1.7 percent per month (the monthly interest rate), we get:

PV = CF / (1 + r)t

where PV is the present value, CF is the cash flow, r is the discount rate, and t is the period.

Using this formula, we get:

PV = $16,696.92 / (1 + 1.7%)^1 = $16,418.85

Finally, we need to calculate the net present value of the switch by subtracting the present value of the additional costs associated with the credit policy. In this case, the only additional cost is the interest expense on carrying the accounts receivable for an additional 30 days. Assuming an average accounts receivable balance of $16,884 (the additional monthly revenue), the monthly interest expense is:

$16,884 x 1.7% = $286.59

The present value of this cost is:

PV = -$286.59 / (1 + 1.7%)^1 = -$280.94

Therefore, the net present value of the switch is:

NPV = $16,418.85 - $280.94 = $16,137.91

This is a positive net present value, indicating that offering the net 30 credit policy is a profitable decision for Blue Bird, Inc. The best choice is C.

Question 12

You are considering renting a kiosk in the local mall for a period of three months.Any sale you make will be a one-time sale.There is only a 79 percent chance you will collect payment on a credit sale.The product you want to sell has a variable cost of $3.88 and a sales price of $4.99.The monthly interest rate is 1.5 percent.Should you offer people 30 days to pay? Why or why not?

Accepted Answer

NPV = -$3.88 + {0.79 × [$4.99/(1 + 0.015)]} = $0

Question 13

Currently, The Toy Box sells 465 units a month at an average price of $42 a unit.The company thinks it can increase sales by an additional 130 units a month if it switches to a net 30 credit policy.The monthly interest rate is 0.4 percent and the variable cost per unit is $21.What is the incremental cash inflow of the proposed credit policy switch?

Accepted Answer

Incremental cash flow = ($42 - $21) (130) = $2,730

Question 14

A firm sells 4,500 units of an item each year.The carrying cost per unit is $2.15 and the fixed costs per order are $69.What is the economic order quantity?

Accepted Answer

EOQ = [(2 × 4,500 × $69)/$2.15]^1/2 = 537 units

Question 15

Weisbrough United currently has a cash sales only policy.Under this policy, the firm sells 410 units a month at a price of $219 a unit.The variable cost per unit is $140 and the carrying cost per unit is $3.30.The monthly interest rate is 1.3 percent.The firm believes it can increase its sales to 475 units a month if it institutes a net 30 credit policy.What is the net present value of the switch using the one-shot approach?

Accepted Answer

Monthly benefit = [($219 × 475)/1.013] - [$140 × 475] - [($219 - $140) × 410] = $3,800.03; NPV of switch = $3,800.03 + ($3,800.03/0.013) = $296,110

Question 16

Saucier & Co.currently sells 2,100 units a month for total monthly sales of $86,500.The company is considering replacing its current cash only credit policy with a net 30 policy.The variable cost per unit is $18 and the monthly interest rate is 1.2 percent.What is the switch break-even level of sales? Assume the selling price per unit and the variable costs per unit remain constant.

Accepted Answer

Break-even point = Q′ - 2,100 = ($86,500)/{[(($86,500/2,100) - $18)/0.012] - $18} = 45 units; Q′ = 2,100 + 45 = 2,145 units

Question 17

Today, October 12, Nadine's Fashions purchased $511 worth of merchandise from a supplier.The credit terms are 1/5, net 20.By what day does Nadine's have to make the payment to receive the discount? Note: October has 31 days.

Accepted Answer

End of discount period = October 12 + 5 days = October 17

Question 18

Polly's Home Accents currently sells 320 units a month at a price of $59 a unit.Polly thinks she can increase her sales by an additional 55 units if she switches to a net 30 credit policy.The monthly interest rate is 0.4 percent and the variable cost per unit is $32.What is the net present value of the proposed credit policy switch?

Accepted Answer

NPV of switch = - [($59 × 320) + ($32 × 55)] + [($59 - $32) × 55]/0.004 = $350,610

Question 19

Each year you sell 950 units of a product at a price of $899 each.The variable cost per unit is $575 and the carrying cost per unit is $16.90.You have been buying 100 units at a time.Your fixed cost of ordering is $60.What is the economic order quantity?

Accepted Answer

EOQ = [(2 × 950 × $60)/$16.90]^1/2 = 82 units

Question 20

Currently, Glasgow Importers sells 280 units a month at a price of $729 a unit.The firm believes it can increase its sales by an additional 40 units if it switches to a net 30 credit policy.The monthly interest rate is 0.5 percent and the variable cost per unit is $480.What is the net present value of the proposed credit policy switch?

Accepted Answer

NPV = - [($729 × 280) + ($480 × 40)] + [($729 - $480) × 40]/0.005 = $1,768,680

Quiz 20: Financial Risk Management