Chapter 20
Credit and Inventory Management
Multiple Choice Questions
1. Blackwell Brothers sells men's suits. The store offers a 1 percent discount if
payment is received within 10 days. Otherwise, payment is due within 30 days.
This credit offering is referred to as the:
A. terms of sale.
B. credit analysis.
C. collection policy.
D. payables policy.
E. collection float.
2. Jillian was recently hired by a major retail store. Her job is to determine the
probability that individual customers will fail to pay for their charge sales. Jillian's
job best relates to which one of the following?
A. terms of sale
B. credit analysis
C. collection policy
D. payables policy
E. customer service
3. Town Hardware sells goods on credit with payment due 30 days after purchase. If
payment is not received by the 30th day, the store mails a friendly reminder to the
customer. If payment is not received by the 45th day, the store calls the customer
and requests payment and also stops offering credit to that customer. These
procedures are referred to as the store's:
A. customer service policy.
B. credit policy.
C. collection policy.
D. payables policy.
E. disbursements policy.
4. Phil's Print Shop grants its customers the right to pay for their print jobs within 30
days of the date of service. This 30-day period is referred to as the:
A. payables period.
B. cash cycle.
C. transactions period.
D. credit period.
E. disbursement period.
5. Scott purchased a shovel, a rake, and a wheelbarrow from The Local Hardware
Store yesterday. Today, the store issued a bill for these items and mailed it to
Scott. What is the name given to this bill?
A. ledger statement
B. warranty
C. indenture
D. receipt
E. invoice
6. Geoff Industries offers its credit customers a 2 percent discount if they pay within
10 days. This discount is referred to as a:
A. cash discount.
B. purchase discount.
C. collection discount.
D. market discount.
E. receivables discount.
7. Any written proof that a customer owes you money for goods or services provided
is referred to as a(n):
A. account document.
B. sales draft.
C. credit instrument.
D. commercial paper.
E. letter of debt.
8. You are viewing a graph which compares costs with the amount of credit
extended. Both the carrying costs and the opportunity costs of credit are depicted.
What is the function called that represents the summation of these carrying and
opportunity costs?
A. opportunity cost curve
B. credit extension curve
C. credit cost curve
D. terms of sale graph
E. optimal sales graph
9. Assume that RSF is a wholly-owned subsidiary of the Rolled Steel Company.
RSF provides credit financing solely for large ticket items purchased from the
Rolled Steel Company. Which one of the following terms describes RSF?
A. credit department
B. parent company
C. captive finance company
D. credit union
E. service unit
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.
11. Roger's Home Appliances offers credit to customers it deems worthy of this
privilege. To determine if a customer is worthy, the firm computes a numerical
value which is used to estimate the probability that the customer will default if
credit is granted to them. The process of computing this numerical value is
referred to as:
A. credit scoring.
B. credit capacity.
C. receipts assessment.
D. conditions for credit.
E. consumer analysis.
12. You have recently been hired as an accounting intern for Jefferson Mills. The job
that you have been assigned for today is to compile a spreadsheet that has six
columns. The column headings are: Invoice #; Customer name; < 30 days; 31-60
days; 61-90 days; > 90 days. You are to list every unpaid invoice by customer
name with the amount owed entered into the appropriate column for the number
of days between the sale date and today. Once you have completed that, you are
to sort the report by customer name and then total the amounts listed in each
column. What is this report called?
A. credit report
B. aging schedule
C. risk assessment report
D. turnover delineation
E. receivables consolidation report
13. Bill is in charge of the inventory for Home Builder's Supply. As an inventory item
gets low, he is to restock the item by a quantity that minimizes the total inventory
costs for that item. What is this restocking quantity called?
A. short order quantity
B. refill unit quantity
C. economic order quantity
D. minimum stock level
E. re-order limit
14. Allison has developed a set of procedures for determining the amount of each raw
material that she needs to have in inventory if she is to keep her firm's assembly
lines operating efficiently. These procedures are commonly referred to by which
one of the following terms?
A. first-in, first-out method
B. the Baumol model
C. net working capital planning
D. economic order procedures
E. materials requirements planning
15. Which one of the following is a system for managing demand-dependent
inventories that minimizes the inventory levels of a firm?
A. just-in-time inventory
B. turnover planning
C. net working capital planning
D. inventory scoring
E. inventory ranking
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
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
18. The period of time that extends from the day a credit sale is made until the day
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. discount
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
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.
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
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.
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
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 plan to forego the discount?
A. store A
B. store B
C. store C
D. store D
E. store E
25. Which one of the following statements is correct?
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 15th of each
month.
26. Which two of the following are the key considerations for a seller who is
establishing the length of the credit period being offered to 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
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
28. Which one of the following statements is correct in regards to 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. Different customers may be offered different credit periods by the same firm.
E. Newer products tend to have shorter credit periods.
29. A cash discount of 2/5, net 30:
A. grants customers 30 days to pay after the discount period expires.
B. offers customers a maximum of 30 days credit.
C. grants free credit for a period of 30 days.
D. charges a higher price to a cash customer than to a customer who pays in 2
days.
E. grants customers 2 days to pay if they want the 5 percent discount.
30. Under credit terms of 1/5, net 15, customers should:
A. always pay on the 15th day.
B. take the 5 percent discount and pay immediately.
C. take the discount and pay on the day following the day of sale.
D. either take the discount or pay on the 15th day.
E. both take the discount and pay on the 15th day.
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 every
customer takes the discount.
D. tends to have little effect on the seller's collection period.
E. tends to increase a firm's investment in receivables as compared to a straight
net 30 policy.
32. The Green Hornet offers a trade discount with terms of 2/5, EOM. Assume you
purchase an item on credit from The Green Hornet on Monday, November 3.
What is the invoice date for this purchase?
A. November 3
B. November 5
C. November 7
D. November 8
E. November 30
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
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.
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 long-term 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
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.
37. The optimal amount of credit equates 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.
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.
39. If you extend credit for a one-time sale to a 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.
40. Which one of the following statements is correct?
A. If the majority of a firm's 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 reveals little information in relation to his or
her future tendency to pay.
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 of credit you will ever be willing to offer as an enticement to get their
business.
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
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.
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
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
45. Which one of the following statements is correct?
A. An aging schedule helps identify those customers who are the most
delinquent.
B. The percentage of total receivables that falls 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.
46. Which one of the following inventory items is probably the least liquid?
A. plywood held in inventory by a home builder
B. a wheel barrow held in inventory by a garden center
C. a partially assembled interior for a new vehicle
D. a set of tires owned by an automobile manufacturer
E. a toy owned by a retail toy store
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. wheat stored in a grain silo
D. a customized drilling press
E. a partially built modular home
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
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.
50. The EOQ 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 given 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.
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. total costs equal the carrying costs.
E. carrying costs equal the restocking costs.
52. The EOQ 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.
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. tires held in inventory by an auto maker
C. shoes on display in a retail store
D. toys ready to be shipped to toy stores
E. wheat harvested by a farmer
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.
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
56. The incremental investment in receivables under the accounts receivable
approach is equal to:
A. P - vQ′.
B. PQ′.
C. PQ + v(Q′ - Q).
D. P(Q′ - Q).
E. PQ(Q′ - Q).
57. The accounts receivable approach to credit policy supports the theory that:
A. a firm's risk of offering credit to a new customer is limited to the variable cost of
the sold items.
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.
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 and IV only
E. III and IV only
59. On average, your firm sells $38,700 of items on credit each day. The firm's
average operating cycle is 49 days and it acquires and sells inventory, on
average, every 17 days. What is the average accounts receivable balance?
A. $657,900
B. $848,000
C. $1,238,400
D. $1,315,500
E. $1,896,300
60. The Winter Store just purchased $48,300 of goods from its supplier with credit
terms of 2/10, net 25. What is the discounted price?
A. $43,470
B. $46,209
C. $47,334
D. $47,929
E. $48,300
61. 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.
A. October 13
B. October 15
C. October 17
D. October 27
E. November 1
62. 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?
A. 27.24 percent
B. 26.57 percent
C. 28.80 percent
D. 29.03 percent
E. 29.27 percent
63. 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?
A. $774
B. $2,625
C. $4,750
D. $5,690
E. $7,375
64. 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?
A. $350,610
B. $350,895
C. $426,507
D. $621,929
E. $821,135
65. 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?
A. -$213,360
B. -$9,240
C. $190,200
D. $1,287,520
E. $1,768,680
66. 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?
A. $2,120
B. $2,730
C. $2,760
D. $2,810
E. $5,070
67. 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.
A. 2,830 units
B. 2,910 units
C. 3,333 units
D. 3,414 units
E. 3,526 units
68. 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.
A. 1,943 units
B. 2,117 units
C. 2,145 units
D. 2,406 units
E. 2,548 units
69. 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?
A. 9,711 units
B. 9,779 units
C. 9,814 units
D. 9,957 units
E. 9,889 units
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 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?
A. yes; because the NPV of the potential sale is $113.05
B. yes; because the NPV of the potential sale is $99.63
C. no; because the NPV of the potential sale is -$133.00
D. no; because the NPV of the potential sale is -113.05
E. no; because the NPV of the potential sale is -$89.65
71. 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?
A. yes; because the NPV of a credit sale is $0.09.
B. yes; because the NPV of a credit sale is $0.03.
C. no; because the NPV of a credit sale is -$0.08.
D. no; because the NPV of a credit sale is -$0.02.
E. It doesn't matter because the NPV of a credit sale is approximately zero.
72. 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?
A. $1,733
B. $1,867
C. $2,617
D. $4,817
E. $8,867
73. 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?
A. yes; because the NPV of extending credit is $8,867
B. yes; because the NPV of extending credit is $9,787
C. yes; because the NPV of extending credit is $128
D. no; because the NPV of extending credit is -$459
E. It doesn't matter because the NPV of extending credit is zero.
74. 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?
A. 374 units
B. 421 units
C. 497 units
D. 537 units
E. 623 units
75. 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?
A. 446 pairs
B. 515 pairs
C. 529 pairs
D. 631 pairs
E. 648 pairs
76. 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?
A. 690 units
B. 747 units
C. 933 units
D. 1,157 units
E. 1,260 units
77. 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?
A. 82 units
B. 95 units
C. 105 units
D. 113 units
E. 124 units
78. 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?
A. $255,590
B. $296,110
C. $298,470
D. $302,233
E. $305,902
79. 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?
A. $212,806
B. $231,543
C. $235,479
D. $248,946
E. $251,118
80. 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?
A. $65,976
B. $66,500
C. $69,081
D. $70,224
E. $73,566
81. You are currently selling 72 units a month at a price of $210 a unit. Your variable
cost of each unit is $130. 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 95 units per month.
The monthly interest rate is 1.5 percent. What is the net present value of this
proposed switch using the accounts receivable approach?
A. $104,557
B. $114,829
C. $134,822
D. $136,516
E. $141,520
82. Your current sales consist of 32 units per month at a price of $225 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 $240 a unit. If you make the switch you do not expect
your total monthly sales quantity to change but you do expect a 3 percent default
rate. The monthly interest rate is 1.5 percent. What is the net present value of the
proposed credit policy switch?
A. $6,727
B. $6,893
C. $7,965
D. $9,440
E. $9,481
83. Your current sales consist of 45 units per month at a price of $390 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 $410 a unit. The monthly interest rate is 1.4 percent.
What is the break-even default rate of the proposed switch?
A. 3.55 percent
B. 3.68 percent
C. 4.29 percent
D. 4.71 percent
E. 4.88 percent
84. The Green Hornet sells earnings forecasts for international securities. Its credit
terms are 2/10, net 30. Based on experience, 55 percent of all customers will take
the discount. The firm sells 2,700 forecasts every month at a price of $1,100
each. What is the firm's average balance sheet amount in accounts receivable?
A. $940,274
B. $1,408,272
C. $1,855,233
D. $1,867,012
E. $1,915,387
85. A firm offers terms of 2/9, net 41. What effective annual interest rate does the firm
earn when a customer does not take the discount?
A. 18.67 percent
B. 20.45 percent
C. 23.37 percent
D. 25.34 percent
E. 25.92 percent
86. Music City, Inc. has an average collection period of 62 days. Its average daily
investment in receivables is $50,000. What are the annual credit sales?
A. $268,407
B. $277,109
C. $294,355
D. $325,893
E. $767,123
87. The Turn It Up Corporation sells on credit terms of net 30. Its accounts are, on
average, 6 days past due. Annual credit sales are $7 million. What is the
company's balance sheet amount in accounts receivable?
A. $690,411
B. $723,333
C. $851,667
D. $915,407
E. $923,593
88. Keep M Flying is a wholesaler that stocks engine components and test equipment
for the commercial aircraft industry. A new customer has placed an order for eight
high-bypass turbine engines, which increase fuel economy. The variable cost is
$1.7 million per unit, and the credit price is $2.1 million each. Credit is extended
for one period. Based on historical experience, payment for about 1 out of every
240 such orders is never collected. The required return is 3.2 percent per period.
What is the NPV per unit if this is a one-time order?
A. $316,407
B. $321,819
C. $326,405
D. $334,290
E. $351,056
89. Quest, Inc., is considering a change in its cash-only sales policy. The new terms
of sale would be one month. The required return is 1.6 percent per month. Based
on the following information, what is the NPV of the new policy?
A. $28,750
B. $32,500
C. $35,000
D. $38,250
E. $40,000
90. Cohen Industrial Products uses 2,100 switch assemblies per week and then
reorders another 2,100. The relevant carrying cost per switch assembly is $18,
and the fixed order cost is $300. What is the EOQ?
A. 1,279.84
B. 1,809.97
C. 1,907.88
D. 2,278.42
E. 2,698.15
91. Roger's Store begins each week with 150 phasers in stock. This stock is depleted
each week and reordered. The carrying cost per phaser is $48 per year and the
fixed order cost is $70. What is the optimal number of orders that should be
placed each year?
A. 48.69
B. 51.71
C. 54.20
D. 61.10
E. 64.50
92. The Dilana Corporation is considering a change in its cash-only policy. The new
terms would be net one period. The required return is 2 percent per period. What
is the NPV of the new policy given the following information?
A. -$230,880
B. -$118,420
C. $311,508
D. $328,997
E. $388,340
93. The Cycle Shoppe has decided to offer credit to its customers during the spring
selling season. Sales are expected to be 330 bicycles. The average cost to the
shop of a bicycle is $300. The owner knows that only 93 percent of the customers
will be able to make their payments. To identify the remaining 7 percent, she is
considering subscribing to a credit agency. The initial charge for this service is
$540, with an additional charge of $6 per individual report. What is the amount of
the net savings from subscribing to the credit agency?
A. $3,790
B. $3,920
C. $4,080
D. $4,410
E. $4,950
Essay Questions
94. Which do you feel is the more appropriate upper limit for the credit period that a
seller offers to a buyer: the buyer's operating cycle or the buyer's inventory
period?
95. 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.
96. Why might firms forego discounts offered by their suppliers even though it is
costly to do so? What steps might a firm pursue to be able to take these
discounts?
97. All else equal, firms with (1) excess capacity, (2) low variable costs, and (3)
repeat customers are more apt to offer liberal credit terms to their customers than
are other firms. Explain why this tendency exists.
Chapter 20 Credit and Inventory Management Answer Key
Multiple Choice Questions
1.
Blackwell Brothers sells men's suits. The store offers a 1 percent discount if
payment is received within 10 days. Otherwise, payment is due within 30 days.
This credit offering is referred to as the:
A. terms of sale.
B. credit analysis.
C. collection policy.
D. payables policy.
E. collection float.
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Terms of sale
2.
Jillian was recently hired by a major retail store. Her job is to determine the
probability that individual customers will fail to pay for their charge sales.
Jillian's job best relates to which one of the following?
A. terms of sale
B. credit analysis
C. collection policy
D. payables policy
E. customer service
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Credit analysis
3.
Town Hardware sells goods on credit with payment due 30 days after
purchase. If payment is not received by the 30th day, the store mails a friendly
reminder to the customer. If payment is not received by the 45th day, the store
calls the customer and requests payment and also stops offering credit to that
customer. These procedures are referred to as the store's:
A. customer service policy.
B. credit policy.
C. collection policy.
D. payables policy.
E. disbursements policy.
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Collection policy
4.
Phil's Print Shop grants its customers the right to pay for their print jobs within
30 days of the date of service. This 30-day period is referred to as the:
A. payables period.
B. cash cycle.
C. transactions period.
D. credit period.
E. disbursement period.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit period
5.
Scott purchased a shovel, a rake, and a wheelbarrow from The Local Hardware
Store yesterday. Today, the store issued a bill for these items and mailed it to
Scott. What is the name given to this bill?
A. ledger statement
B. warranty
C. indenture
D. receipt
E. invoice
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Invoice
6.
Geoff Industries offers its credit customers a 2 percent discount if they pay
within 10 days. This discount is referred to as a:
A. cash discount.
B. purchase discount.
C. collection discount.
D. market discount.
E. receivables discount.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Cash discounts
7.
Any written proof that a customer owes you money for goods or services
provided is referred to as a(n):
A. account document.
B. sales draft.
C. credit instrument.
D. commercial paper.
E. letter of debt.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit instruments
8.
You are viewing a graph which compares costs with the amount of credit
extended. Both the carrying costs and the opportunity costs of credit are
depicted. What is the function called that represents the summation of these
carrying and opportunity costs?
A. opportunity cost curve
B. credit extension curve
C. credit cost curve
D. terms of sale graph
E. optimal sales graph
Refer to section 20.4
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.4
Topic: Credit cost curve
9.
Assume that RSF is a wholly-owned subsidiary of the Rolled Steel Company.
RSF provides credit financing solely for large ticket items purchased from the
Rolled Steel Company. Which one of the following terms describes RSF?
A. credit department
B. parent company
C. captive finance company
D. credit union
E. service unit
Refer to section 20.4
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.4
Topic: Captive finance company
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.
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Five Cs of credit
11.
Roger's Home Appliances offers credit to customers it deems worthy of this
privilege. To determine if a customer is worthy, the firm computes a numerical
value which is used to estimate the probability that the customer will default if
credit is granted to them. The process of computing this numerical value is
referred to as:
A. credit scoring.
B. credit capacity.
C. receipts assessment.
D. conditions for credit.
E. consumer analysis.
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Credit scoring
12.
You have recently been hired as an accounting intern for Jefferson Mills. The
job that you have been assigned for today is to compile a spreadsheet that has
six columns. The column headings are: Invoice #; Customer name; < 30 days;
31-60 days; 61-90 days; > 90 days. You are to list every unpaid invoice by
customer name with the amount owed entered into the appropriate column for
the number of days between the sale date and today. Once you have
completed that, you are to sort the report by customer name and then total the
amounts listed in each column. What is this report called?
A. credit report
B. aging schedule
C. risk assessment report
D. turnover delineation
E. receivables consolidation report
Refer to section 20.6
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.6
Topic: Aging schedule
13.
Bill is in charge of the inventory for Home Builder's Supply. As an inventory
item gets low, he is to restock the item by a quantity that minimizes the total
inventory costs for that item. What is this restocking quantity called?
A. short order quantity
B. refill unit quantity
C. economic order quantity
D. minimum stock level
E. re-order limit
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic reorder quantity
14.
Allison has developed a set of procedures for determining the amount of each
raw material that she needs to have in inventory if she is to keep her firm's
assembly lines operating efficiently. These procedures are commonly referred
to by which one of the following terms?
A. first-in, first-out method
B. the Baumol model
C. net working capital planning
D. economic order procedures
E. materials requirements planning
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Materials requirements planning
15.
Which one of the following is a system for managing demand-dependent
inventories that minimizes the inventory levels of a firm?
A. just-in-time inventory
B. turnover planning
C. net working capital planning
D. inventory scoring
E. inventory ranking
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Just-In-Time inventory
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
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
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
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Credit analysis
18.
The period of time that extends from the day a credit sale is made until the day
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. discount
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Accounts receivable period
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
Refer to section 20.1
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
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.
Refer to section 20.1
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
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
Refer to section 20.1
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Investment in receivables
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.
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
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
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Terms of sale
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 plan to forego the discount?
A. store A
B. store B
C. store C
D. store D
E. store E
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Terms of sale
25.
Which one of the following statements is correct?
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 15th of
each month.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit period
26.
Which two of the following are the key considerations for a seller who is
establishing the length of the credit period being offered to 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
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
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
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit period
28.
Which one of the following statements is correct in regards to 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. Different customers may be offered different credit periods by the same firm.
E. Newer products tend to have shorter credit periods.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit period
29.
A cash discount of 2/5, net 30:
A. grants customers 30 days to pay after the discount period expires.
B. offers customers a maximum of 30 days credit.
C. grants free credit for a period of 30 days.
D. charges a higher price to a cash customer than to a customer who pays in 2
days.
E. grants customers 2 days to pay if they want the 5 percent discount.
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Cash discounts
30.
Under credit terms of 1/5, net 15, customers should:
A. always pay on the 15th day.
B. take the 5 percent discount and pay immediately.
C. take the discount and pay on the day following the day of sale.
D. either take the discount or pay on the 15th day.
E. both take the discount and pay on the 15th day.
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Cash 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 every
customer takes the discount.
D. tends to have little effect on the seller's collection period.
E. tends to increase a firm's investment in receivables as compared to a
straight net 30 policy.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Cost of credit
32.
The Green Hornet offers a trade discount with terms of 2/5, EOM. Assume you
purchase an item on credit from The Green Hornet on Monday, November 3.
What is the invoice date for this purchase?
A. November 3
B. November 5
C. November 7
D. November 8
E. November 30
Refer to section 20.2
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
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
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
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.
Refer to section 20.2
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Credit instruments
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 long-term 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
Refer to section 20.3
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
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.
Refer to section 20.3
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Evaluating credit policy
37.
The optimal amount of credit equates 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.
Refer to section 20.4
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.4
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.
Refer to section 20.4
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.4
Topic: Optimal credit policy
39.
If you extend credit for a one-time sale to a 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.
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Credit analysis
40.
Which one of the following statements is correct?
A. If the majority of a firm's 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 reveals little information in relation to his
or her future tendency to pay.
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 of credit you will ever be willing to offer as an enticement
to get their business.
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
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
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
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.
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Five Cs of credit
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
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
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
Refer to section 20.5
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Five Cs of credit
45.
Which one of the following statements is correct?
A. An aging schedule helps identify those customers who are the most
delinquent.
B. The percentage of total receivables that falls 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.
Refer to section 20.6
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.6
Topic: Collection policy
46.
Which one of the following inventory items is probably the least liquid?
A. plywood held in inventory by a home builder
B. a wheel barrow held in inventory by a garden center
C. a partially assembled interior for a new vehicle
D. a set of tires owned by an automobile manufacturer
E. a toy owned by a retail toy store
Refer to section 20.7
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.7
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. wheat stored in a grain silo
D. a customized drilling press
E. a partially built modular home
Refer to section 20.7
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.7
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
Refer to section 20.7
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.7
Topic: Inventory costs
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.
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.8
Topic: Inventory management techniques
50.
The EOQ 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 given 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.
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
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. total costs equal the carrying costs.
E. carrying costs equal the restocking costs.
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
52.
The EOQ 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.
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
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. tires held in inventory by an auto maker
C. shoes on display in a retail store
D. toys ready to be shipped to toy stores
E. wheat harvested by a farmer
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.8
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.
Refer to section 20.8
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.8
Topic: Derived-demand inventory
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
Refer to section 20.8
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.8
Topic: Just-In-Time inventory
56.
The incremental investment in receivables under the accounts receivable
approach is equal to:
A. P - vQ′.
B. PQ′.
C. PQ + v(Q′ - Q).
D. P(Q′ - Q).
E. PQ(Q′ - Q).
Refer to section 20.A
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Accounts receivable approach
57.
The accounts receivable approach to credit policy supports the theory that:
A. a firm's risk of offering credit to a new customer is limited to the variable cost
of the sold items.
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.
Refer to section 20.A
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Accounts receivable approach
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 and IV only
E. III and IV only
Refer to section 20.A
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: NPV of switch
59.
On average, your firm sells $38,700 of items on credit each day. The firm's
average operating cycle is 49 days and it acquires and sells inventory, on
average, every 17 days. What is the average accounts receivable balance?
A. $657,900
B. $848,000
C. $1,238,400
D. $1,315,500
E. $1,896,300
Accounts receivable balance = $38,700 × (49 - 17) = $1,238,400
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Accounts receivable balance
60.
The Winter Store just purchased $48,300 of goods from its supplier with credit
terms of 2/10, net 25. What is the discounted price?
A. $43,470
B. $46,209
C. $47,334
D. $47,929
E. $48,300
Discounted price = $48,300 × (1 - 0.02) = $47,334
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Accounts receivable discount
61.
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.
A. October 13
B. October 15
C. October 17
D. October 27
E. November 1
End of discount period = October 12 + 5 days = October 17
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Accounts receivable discount
62.
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?
A. 27.24 percent
B. 26.57 percent
C. 28.80 percent
D. 29.03 percent
E. 29.27 percent
Days in period = 40 - 10 = 30; Periods per year = 365/30 = 12.166667
Interest rate for 30 days = [0.02 × $4,800]/[(1 - 0.02) × $4,800] = 0.0195578
Effective annual rate = (1 + .01955780195578)12.166667 - 1 = 26.57 percent
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Accounts receivable discount
63.
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?
A. $774
B. $2,625
C. $4,750
D. $5,690
E. $7,375
Incremental cash flow = ($59 - $38) (125) = $2,625
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Credit policy switch
64.
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?
A. $350,610
B. $350,895
C. $426,507
D. $621,929
E. $821,135
NPV of switch = - [($59 × 320) + ($32 × 55)] + [($59 - $32) × 55]/0.004 =
$350,610
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Credit policy switch
65.
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?
A. -$213,360
B. -$9,240
C. $190,200
D. $1,287,520
E. $1,768,680
NPV = - [($729 × 280) + ($480 × 40)] + [($729 - $480) × 40]/0.005 =
$1,768,680
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Credit policy switch
66.
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?
A. $2,120
B. $2,730
C. $2,760
D. $2,810
E. $5,070
Incremental cash flow = ($42 - $21) (130) = $2,730
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Credit policy switch
67.
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.
A. 2,830 units
B. 2,910 units
C. 3,333 units
D. 3,414 units
E. 3,526 units
Break-even point = Q′ - 2,800 = ($40 × 2,800)/{[($40 - $21)/0.005] - $21} = 30
units
Q′ = 2,800 + 30 = 2,830 units
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-03 The types of inventory and inventory management systems used by firms.
Section: 20.3
Topic: Switch break-even point
68.
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.
A. 1,943 units
B. 2,117 units
C. 2,145 units
D. 2,406 units
E. 2,548 units
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
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Switch break-even point
69.
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?
A. 9,711 units
B. 9,779 units
C. 9,814 units
D. 9,957 units
E. 9,889 units
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
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Switch break-even point
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 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?
A. yes; because the NPV of the potential sale is $113.05
B. yes; because the NPV of the potential sale is $99.63
C. no; because the NPV of the potential sale is -$133.00
D. no; because the NPV of the potential sale is -113.05
E. no; because the NPV of the potential sale is -$89.65
NPV = -$156 + {[1 - 0.10] × [$289/(1 + 0.0175)]} = $99.63
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: One-time sale
71.
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?
A. yes; because the NPV of a credit sale is $0.09.
B. yes; because the NPV of a credit sale is $0.03.
C. no; because the NPV of a credit sale is -$0.08.
D. no; because the NPV of a credit sale is -$0.02.
E. It doesn't matter because the NPV of a credit sale is approximately zero.
NPV = -$3.88 + {0.79 × [$4.99/(1 + 0.015)]} = $0
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: One-time sale
72.
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?
A. $1,733
B. $1,867
C. $2,617
D. $4,817
E. $8,867
PV = ($69 - $41)/0.015 = $1,867
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Repeat sale
73.
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?
A. yes; because the NPV of extending credit is $8,867
B. yes; because the NPV of extending credit is $9,787
C. yes; because the NPV of extending credit is $128
D. no; because the NPV of extending credit is -$459
E. It doesn't matter because the NPV of extending credit is zero.
NPV = -$435 + {[1 - 0.09] × [($619 - $435)/0.018]} = $8,867
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Repeat sale
74.
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?
A. 374 units
B. 421 units
C. 497 units
D. 537 units
E. 623 units
EOQ = [(2 × 4,500 × $69)/$2.15]1/2 = 537 units
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
75.
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?
A. 446 pairs
B. 515 pairs
C. 529 pairs
D. 631 pairs
E. 648 pairs
EOQ = [(2 × 5,700 × $68)/$1.95]1/2 = 631 pairs
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
76.
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?
A. 690 units
B. 747 units
C. 933 units
D. 1,157 units
E. 1,260 units
EOQ = [(2 × 6,500 × $75)/$1.12]1/2 = 933 units
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
77.
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?
A. 82 units
B. 95 units
C. 105 units
D. 113 units
E. 124 units
EOQ = [(2 × 950 × $60)/$16.90]1/2 = 82 units
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Economic order quantity
78.
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?
A. $255,590
B. $296,110
C. $298,470
D. $302,233
E. $305,902
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
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: One-shot approach
79.
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?
A. $212,806
B. $231,543
C. $235,479
D. $248,946
E. $251,118
Monthly benefit = {[$469 × (215 + 36)]/(1 + 0.017)} - {$305 × (215 + 36)} {($469 - $305) × 215} = $3,936.23; NPV of switch = $3,936.23 +
($3,936.23/0.017) = $235,479
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: One-shot approach
80.
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?
A. $65,976
B. $66,500
C. $69,081
D. $70,224
E. $73,566
P = $9,900/132 = $75
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Accounts receivable approach
81.
You are currently selling 72 units a month at a price of $210 a unit. Your
variable cost of each unit is $130. 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 95
units per month. The monthly interest rate is 1.5 percent. What is the net
present value of this proposed switch using the accounts receivable
approach?
A. $104,557
B. $114,829
C. $134,822
D. $136,516
E. $141,520
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Accounts receivable approach
82.
Your current sales consist of 32 units per month at a price of $225 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 $240 a unit. If you make the switch you do not
expect your total monthly sales quantity to change but you do expect a 3
percent default rate. The monthly interest rate is 1.5 percent. What is the net
present value of the proposed credit policy switch?
A. $6,727
B. $6,893
C. $7,965
D. $9,440
E. $9,481
d = ($240 - $225)/$240 = 0.0625
NPV = - ($225 × 32) + {($240 × 32) × [(0.0625 - 0.03)/0.015]} = $9,440
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Discounts and default risk
83.
Your current sales consist of 45 units per month at a price of $390 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 $410 a unit. The monthly interest rate is 1.4
percent. What is the break-even default rate of the proposed switch?
A. 3.55 percent
B. 3.68 percent
C. 4.29 percent
D. 4.71 percent
E. 4.88 percent
d = ($410 - $390)/$410 = 0.048780488
π = 0.048780488 - 0.014 (1 - 0.048780488) = 3.55 percent
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.A
Topic: Discounts and default risk
84.
The Green Hornet sells earnings forecasts for international securities. Its credit
terms are 2/10, net 30. Based on experience, 55 percent of all customers will
take the discount. The firm sells 2,700 forecasts every month at a price of
$1,100 each. What is the firm's average balance sheet amount in accounts
receivable?
A. $940,274
B. $1,408,272
C. $1,855,233
D. $1,867,012
E. $1,915,387
Average collection period = 0.55(10 days) + 0.45 (30 days) = 19 days
Average A/R = 2,700 ($1,100) (12/365) (19) = $1,855,233
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-3
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Accounts receivable
85.
A firm offers terms of 2/9, net 41. What effective annual interest rate does the
firm earn when a customer does not take the discount?
A. 18.67 percent
B. 20.45 percent
C. 23.37 percent
D. 25.34 percent
E. 25.92 percent
EAR = [1 + (0.02/0.98)]365/(41 - 9) - 1 = 25.92 percent
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-5
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Terms of sale
86.
Music City, Inc. has an average collection period of 62 days. Its average daily
investment in receivables is $50,000. What are the annual credit sales?
A. $268,407
B. $277,109
C. $294,355
D. $325,893
E. $767,123
Annual credit sales = $50,000 (365/62) = $294,355
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-6
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Receivables turnover
87.
The Turn It Up Corporation sells on credit terms of net 30. Its accounts are, on
average, 6 days past due. Annual credit sales are $7 million. What is the
company's balance sheet amount in accounts receivable?
A. $690,411
B. $723,333
C. $851,667
D. $915,407
E. $923,593
A/R = $7,000,000 [(30 + 6)/365] = $690,411
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-8
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.1
Topic: Accounts receivable
88.
Keep M Flying is a wholesaler that stocks engine components and test
equipment for the commercial aircraft industry. A new customer has placed an
order for eight high-bypass turbine engines, which increase fuel economy. The
variable cost is $1.7 million per unit, and the credit price is $2.1 million each.
Credit is extended for one period. Based on historical experience, payment for
about 1 out of every 240 such orders is never collected. The required return is
3.2 percent per period. What is the NPV per unit if this is a one-time order?
A. $316,407
B. $321,819
C. $326,405
D. $334,290
E. $351,056
NPV = -$1,700,000 + [1 - (1/240)] [$2,100,000]/(1 + 0.032) = $326,405
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-9
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.3
Topic: Credit policy
89.
Quest, Inc., is considering a change in its cash-only sales policy. The new
terms of sale would be one month. The required return is 1.6 percent per
month. Based on the following information, what is the NPV of the new policy?
A. $28,750
B. $32,500
C. $35,000
D. $38,250
E. $40,000
Benefit of switching = ($800 - $425) (1,150 - 1,110) = $15,000
Cost of switching = $800 (1,110) + $425 (1,150 - 1,110) = $905,000
New policy NPV = $15,000/0.016 - $905,000 = $32,500
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-10
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.3
Topic: Credit policy evaluation
90.
Cohen Industrial Products uses 2,100 switch assemblies per week and then
reorders another 2,100. The relevant carrying cost per switch assembly is $18,
and the fixed order cost is $300. What is the EOQ?
A. 1,279.84
B. 1,809.97
C. 1,907.88
D. 2,278.42
E. 2,698.15
EOQ = [(2 × 52 × 2,100 × 300)/$18]½ = 1,907.88
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-11
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: EOQ
91.
Roger's Store begins each week with 150 phasers in stock. This stock is
depleted each week and reordered. The carrying cost per phaser is $48 per
year and the fixed order cost is $70. What is the optimal number of orders that
should be placed each year?
A. 48.69
B. 51.71
C. 54.20
D. 61.10
E. 64.50
EOQ = [(2 × 52 × 150 × $70)/$48]1/2 = 150.83
Number of orders per year = 52(150)/150.83 = 51.71
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
EOC: 20-12
Learning Objective: 20-04 How to determine the costs of carrying inventory and the optimal inventory level.
Section: 20.8
Topic: Optimal order quantity
92.
The Dilana Corporation is considering a change in its cash-only policy. The
new terms would be net one period. The required return is 2 percent per
period. What is the NPV of the new policy given the following information?
A. -$230,880
B. -$118,420
C. $311,508
D. $328,997
E. $388,340
Cash flow from old policy = ($71 - $36) (3,500) = $122,500
Cash flow from new policy = ($74 - $36) (3,560) = $135,280
Incremental cash flow = $135,280 - $122,500 = $12,780
NPV of new policy = - [$71(3,500) + $36(3,560 - 3,500)] + $12,780/0.02 =
$388,340
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 20-14
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Credit policy
93.
The Cycle Shoppe has decided to offer credit to its customers during the spring
selling season. Sales are expected to be 330 bicycles. The average cost to the
shop of a bicycle is $300. The owner knows that only 93 percent of the
customers will be able to make their payments. To identify the remaining 7
percent, she is considering subscribing to a credit agency. The initial charge for
this service is $540, with an additional charge of $6 per individual report. What
is the amount of the net savings from subscribing to the credit agency?
A. $3,790
B. $3,920
C. $4,080
D. $4,410
E. $4,950
Net savings = (330 × $300 × 0.07) - $540 - (330 × $6) = $4,410
AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
EOC: 20-16
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Credit policy
Essay Questions
94.
Which do you feel is the more appropriate upper limit for the credit period that 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.
Feedback: Refer to section 20.2
AACSB: Reflective Thinking
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.2
Topic: Length of credit period
95.
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 is debatable, but this practice
occurs fairly frequently.
Feedback: Refer to section 20.2
AACSB: Ethics
AACSB: Reflective Thinking
Blooms: Evaluate
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.2
Topic: Ethics and the credit period
96.
Why might firms forego discounts offered by their suppliers 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 there is insufficient cash flow to pay within the
discount period. 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
financing 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, the firm's management needs to
seriously review the firm's cash and liquidity policies and make the changes
required to improve the firm's liquidity and cash flow situation.
Feedback: Refer to section 20.2
AACSB: Reflective Thinking
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies.
Section: 20.2
Topic: Discounts
97.
All else equal, firms with (1) excess capacity, (2) low variable costs, and (3)
repeat customers are more apt to offer liberal credit terms to their customers
than are other firms. Explain why this tendency exists.
Firms with excess capacity are more apt to offer liberal credit terms as a sales
incentive as increased sales will also increase the capacity utilization ratio.
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 its customers' ability to pay, thereby facilitating
more liberal credit terms.
Feedback: Refer to section 20.5
AACSB: Reflective Thinking
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 20-02 How to analyze the decision by a firm to grant credit.
Section: 20.5
Topic: Liberal credit terms