Chapter 28 Credit and Inventory Management: Corporate Finance, 12e (Ross)

Corporate Finance, 12e (Ross)
Chapter 28 Credit and Inventory Management
1) Selling goods and services on credit is:

A) an investment in a customer.
B) never necessary unless customers cannot pay for the goods.
C) a decision independent of customers.
D) permissible only if your bank lends the money.
E) never a wise decision.
Answer: A
Difficulty: 1 Easy
Section: 28.1 Credit and Receivables
Topic: Credit policy
Bloom's: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
2) When credit is granted by one firm to another firm this gives rise to a(n):
A) accounts receivable and is called consumer credit.
B) credit due and is called an installment note.
C) accounts receivable and is called trade credit.
D) trade receivable and is called an installment note.
E) trade receivable and is called a secured loan.
Answer: C
Difficulty: 1 Easy
Bloom's: Remember
3) The average collection period measures the average:

A) time necessary to collect a credit sale.
B) number of customers per day who charge their purchases.
C) time for a credit customer to return to make a second purchase.
D) number of times a credit customer charges a purchase during a year.
E) number of items purchased in each credit transaction.
Answer: A
Difficulty: 1 Easy
Bloom's: Remember
1
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4) The three components of credit policy are:
A) collection policy, credit analysis, and interest rate determination.
B) collection policy, credit analysis, and terms of the sale.
C) collection policy, interest rate determination, and repayment analysis.
D) credit analysis, repayment analysis, and terms of the sale.
E) interest rate determination, repayment analysis, and terms of sale.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
5) Credit analysis is best described as the process of:

A) collecting an accounts receivable.
B) determining the optimal credit terms.
C) establishing the length of the credit period.
D) setting the amount of discount to be granted.
E) determining the probability that a customer will not pay.
Answer: E
Difficulty: 1 Easy
Topic: Credit policy analysis
Bloom's: Understand
6) Seasonal dating is used to promote sales during the off-season. This process involves:
A) extending the credit period until after the season ends.
B) extending both the discount period and the credit period by two months.
C) accepting orders early but withholding shipment until the peak season.
D) accepting orders early but dating the invoice when the goods are actually shipped.
E) dating an invoice at a later date than when the goods are shipped.
Answer: E
Difficulty: 1 Easy
Section: 28.2 Terms of the Sale
Topic: Credit terms
Bloom's: Understand
2
7) Credit terms of 1/5, net 15 should be interpreted as granting:
A) a 1/5 percent discount for payments within 15 days.
B) a five percent discount for next day payments.
C) a total credit period of 20 days.
D) a credit period of 10 days.
E) a one percent discount for payments received within five days.
Answer: E
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
8) The credit period begins on the:

A) shipping date.
B) purchase order date.
C) shipping arrival date.
D) order process date.
E) invoice date.
Answer: E
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
9) On September 1, a firm grants credit with terms of 2/10 net 30. The creditor:
A) must pay a penalty of 2/10 of one percent when payment is made later than October 1.
B) must pay a penalty of 10 percent when payment is made later than 2 days after October 1.
C) receives a discount of 2 percent when payment is made at least 10 days prior to October 1.
D) receives a discount of 2 percent when payment is made on September 1 and pays a penalty of
10 percent if payment is made after October 1.
E) receives a discount of 2 percent when payment is made within 10 days.
Answer: E
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
3
10) The length of the credit period offered by a firm is influenced by all of the following except
the:
A) level of consumer demand.
B) buyer's operating cycle.
C) standardization of the goods being sold.
D) FTC guidelines for trade credit.
E) customer type.
Answer: D
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
11) Seasonal dating of accounts receivable:

A) is used by all firms that grant credit.
B) sets the first date of the relevant season as the final due date for an invoice for seasonal goods.
C) sets a relevant seasonal date as the invoice date for an earlier order.
D) refers to firms that invoice every quarter for sales made in the prior three months.
E) requires all purchasers of seasonal goods to have their purchases paid by the end of the prior
season.
Answer: C
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
4
12) Which one of the following statements is false as it relates to considerations firms use when
establishing a credit policy?
A) A firm that supplies a perishable product will tend to offer restrictive credit terms.
B) A firm whose customers are in a high-risk business will tend to offer restrictive credit terms.
C) Lengthening the credit period effectively reduces the price paid by the customer.
D) Small accounts, associated with firms that find it difficult to acquire a line of credit, tend to
receive longer credit periods.
E) Larger accounts tend to receive more favorable credit terms.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
13) The upper limit to the credit period is best expressed as the length of the:
A) seller's operating cycle.
B) seller's cash cycle.
C) seller's payables period.
D) buyer's operating cycle.
E) buyer's cash cycle.
Answer: D
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Understand
14) Cash discounts:

A) increase the amount of credit offered.
B) increase profit margins on sales.
C) speed up the collection of receivables.
D) were first offered in the early 1900s.
E) are a cost-free means of increasing sales.
Answer: C
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Remember
5
15) With an open account the formal instrument of credit is the:
A) purchase order.
B) invoice.
C) promissory note.
D) banker's acceptance.
E) secured loan document.
Answer: B
Difficulty: 1 Easy
Topic: Credit instruments
Bloom's: Understand
16) Which one of these statements is true regarding promissory notes?

A) Most trade credit arrangements use promissory notes.
B) Promissory notes are used when firms do not anticipate a problem with collections.
C) Promissory notes usually involve no cash discount.
D) A promissory note must be signed and delivered prior to goods being shipped.
E) Promissory notes are used for small orders only.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
17) A commercial draft typically:

A) specifies the payment amount and payment due date.
B) specifies that the purchaser use the seller's bank as the guarantor.
C) requires payment prior to the delivery of the goods.
D) is signed upon delivery of the goods.
E) involves a lien on the purchasers' current assets.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
6
18) Which one of the following statements is false?
A) Commercial drafts represent a way to obtain a credit commitment from a customer before the
goods are delivered.
B) When a banker's acceptance is discounted in the secondary market it becomes a commercial
note.
C) Sight drafts require immediate payment.
D) Banker's acceptances arise when a bank guarantees payment on a commercial draft.
E) A commercial draft becomes a trade acceptance once the buyer accepts the draft and promises
to pay.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
19) One characteristic of a conditional sales contract is that the:

A) seller retains legal ownership until the buyer completes payment for the goods.
B) buyer is compensated for its opportunity costs.
C) seller receives a prepayment in full.
D) invoice is paid in one lump sum at the end of the credit period.
E) ownership of the goods changes to the buyer immediately upon delivery.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
20) The net credit period for a company with terms of 2/10, net 45 is:
A) 10 days.
B) 45 days.
C) 35 days.
D) 55 days.
E) 40 days.
Answer: B
Difficulty: 1 Easy
Topic: Credit terms
Bloom's: Remember
7
21) The decision to grant credit should consider all the following except the:
A) delay in revenues from granting credit.
B) immediate costs of granting credit.
C) probability of nonpayment.
D) cost of short-term borrowing.
E) fixed costs incurred during the credit period.
Answer: E
Difficulty: 1 Easy
Section: 28.3 Analyzing Credit Policy
Bloom's: Understand
22) When analyzing the NPV of a decision to switch from a cash-only sales policy to a credit
policy with an early payment discount, the firm is least apt to consider the:
A) size of the discount.
B) length of the credit period.
C) firm's variable costs.
D) expected change in sales.
E) fixed salaries of the sales force.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
23) When analyzing the decision to change the cash discount policy, the firm should select the
policy that has the:
A) highest order size.
B) lowest variable cost per unit.
C) lowest NPV.
D) highest NPV.
E) lowest cash discount.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
8
24) Assume you graph the costs of granting credit against the amount of credit extended. The
optimal credit amount is then determined by the point which:
A) minimizes the total cost curve.
B) maximizes the carrying costs associated with granting credit.
C) maximizes the opportunity costs associated with granting credit.
D) minimizes the carrying costs of granting credit.
E) minimizes the opportunity costs of granting credit.
Answer: A
Difficulty: 1 Easy
Section: 28.4 Optimal Credit Policy
Topic: Optimal credit policy
Bloom's: Understand
25) Determining the optimal credit policy is based on a trade-off between the carrying costs of
granting credit and the:
A) lost profits from refusing credit.
B) cash flows delayed from granting credit.
C) opportunity cost of the delayed payments.
D) variable costs associated with the delayed payments.
E) present value of uncollected sales.
Answer: A
Difficulty: 1 Easy
Topic: Optimal credit policy
Bloom's: Understand
26) One key reason for establishing a captive finance company is the:
A) reduction of legal restrictions on the amount of debt that can be incurred.
B) increased opportunities for internal sales.
C) lower level of required financial insurance.
D) anticipated decrease in accounts receivable.
E) expected decrease in the cost of the debt required to finance receivables.
Answer: E
Difficulty: 1 Easy
Topic: Credit management
Bloom's: Understand
9
27) All the following can provide credit information about a customer except:
A) the customer's financial statements.
B) credit reports.
C) the customer's current payment history with the seller.
D) the amount of goods the customer desires to purchase.
E) banks.
Answer: D
Difficulty: 1 Easy
Section: 28.5 Credit Analysis
Topic: Credit analysis
Bloom's: Understand
28) Since the credit decision usually includes riskier customers, the decision should adjust for
this by:
A) determining the probability of nonpayment and reducing the expected cash flows accordingly.
B) discounting the net cash flows at a lower discount rate.
C) discounting the cash inflows at a higher discount rate.
D) increasing the variable cost per unit.
E) decreasing the variable cost per unit.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
29) All the following are one of the "Five C's of Credit" except:
A) capability.
B) capacity.
C) capital.
D) character.
E) conditions.
Answer: A
Difficulty: 1 Easy
Bloom's: Remember
10
30) Which one of the following statements is false?
A) An aging schedule includes only overdue accounts.
B) Aging schedules are used to monitor accounts receivable.
C) If sales are seasonal, the percentages shown on an aging schedule will vary during the year.
D) Collection efforts may involve legal action.
E) Investments in accounts receivable equal average daily sales times average collection period.
Answer: A
Difficulty: 1 Easy
Section: 28.6 Collection Policy
Topic: Collection policy
Bloom's: Understand
31) To collect on the accounts receivable due to the firm, a firm can do all the following except:
A) send a delinquency letter of past due status to the customer.
B) make personal contact by telephone.
C) employ a collection agency.
D) take legal action against the customer as necessary.
E) forcibly remove property from the buyer's premises.
Answer: E
Difficulty: 1 Easy
Section: 28.6 Collection Policy
Topic: Collection policy
Bloom's: Understand
32) Windshield glass purchased by an automaker and sitting on a shelf ready for use is classified
as:
A) finished goods inventory.
B) raw materials.
C) assembly materials.
D) work-in-progress.
E) partial-goods inventory.
Answer: B
Difficulty: 1 Easy
Section: 28.7 Inventory Management
Topic: Inventory types
Bloom's: Understand
11
33) Which one of these statements is correct?
A) Finished goods are classified as a commodity.
B) Work-in-progress may have less resell value than the individual component parts did.
C) Raw materials that are considered to be a commodity are generally illiquid.
D) Raw materials consist of only those goods that are found in nature.
E) Finished goods are highly liquid because they are completed.
Answer: B
Difficulty: 1 Easy
Topic: Inventory types
Bloom's: Understand
34) All of these are carrying costs of inventory except:

A) storage costs.
B) insurance.
C) restocking costs.
D) theft.
E) the opportunity cost of capital.
Answer: C
Difficulty: 1 Easy
Topic: Inventory costs
Bloom's: Understand
35) The basic assumption of the ABC approach to inventory management is that:
A) inventory should be divided dependent on the type of cash or credit sale anticipated.
B) most items are ordered, stocked, and sold in a relatively short period of time.
C) firms should receive A customer's order Before incurring inventory Costs.
D) a small portion of inventory represents a large portion of inventory costs.
E) firms should Always Be Consistent in the amount of inventory ordered.
Answer: D
Difficulty: 1 Easy
Section: 28.8 Inventory Management Techniques
Topic: ABC inventory management
Bloom's: Understand
12
36) At the optimal inventory level, the:
A) inventory is held to its daily minimum level.
B) inventory is maintained at a level equal to one week's production needs.
C) carrying costs equal the restocking costs.
D) inventory opportunity costs are zero.
E) shortage costs are eliminated.
Answer: C
Difficulty: 1 Easy
Topic: Inventory management
Bloom's: Understand
37) The EOQ model considers all the following except the:
A) cost of the inventory.
B) carrying cost.
C) fixed cost of an order.
D) restocking cost.
E) annual sales units.
Answer: A
Difficulty: 1 Easy
Topic: Economic order quantity (EOQ) model
Bloom's: Understand
38) The EOQ model assumes inventory:

A) is held at a constant level.
B) is sold at a steady rate until it is depleted.
C) will be available just as it is needed for production.
D) has seasonal fluctuations.
E) can be delivered immediately upon order.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
13
39) The minimum level of inventory that a firm wants to keep on hand at all times is referred to
as:
A) the base level.
B) safety stock.
C) the opportunity cost.
D) the reorder point.
E) keiretsu.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
40) The total restocking cost is calculated as:

A) Fixed cost per order × Number of orders.
B) Order size × Variable cost per unit.
C) Carrying costs + Fixed costs.
D) Number of orders × Variable cost per unit.
E) Fixed cost per unit × Average inventory.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
41) The reorder point considers all the following except the:
A) safety stock.
B) variable costs per unit.
C) delivery time.
D) minimum desired inventory level.
E) rate of sales.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
14
42) The first step in materials requirements planning is establishing the:
A) desired minimum raw materials inventory level.
B) finished goods inventory level.
C) cost of each order.
D) delivery time required for each type of raw material.
E) value of each inventory item as a percent of total inventory.
Answer: B
Difficulty: 1 Easy
Topic: Derived-demand inventory management
Bloom's: Understand
43) For a JIT inventory system to be efficient, the:

A) inventory must have an independent demand.
B) firm's suppliers need to be able to deliver goods quickly upon order.
C) managers must limit production each day to a set quantity.
D) firm must be a reseller of goods, not a manufacturer.
E) supplying firm must be a subsidiary of the ordering firm.
Answer: B
Difficulty: 1 Easy
Topic: Derived-demand inventory management
Bloom's: Understand
15
44) Crocket Motors has an account receivable balance of $682,400 and the average collection
period is 38 days. What are the firm's credit sales per day?
A) $17,957.89
B) $23,333.33
C) $71,044.38
D) $259,312.00
E) $236,408.11
Answer: A
Explanation: Daily credit sales = Accounts receivable/Average collection period
Daily credit sales = $682,400/38
Daily credit sales = $17,957.89
Difficulty: 2 Medium
Topic: Accounts receivable
Bloom's: Apply
AACSB: Knowledge Application
45) Delta Distributors has accounts receivable of $2,750,000 and average daily credit sales of
$118,280. The firm offers credit terms of 2/10, net 30. On average, what is the firm's accounts
receivable period?
A) 19.47 days
B) 23.25 days
C) 37.14 days
D) 20.00 days
E) 18.64 days
Answer: B
Explanation: Accounts receivable period = Accounts receivable/Average daily sales
Accounts receivable period = $2,750,000/$118,280
Accounts receivable period = 23.25 days
Bloom's: Apply
16
46) If 34 percent of customers pay on Day 10 and the remainder pay in an average of 28 days,
what is the average collection period?
A) 19.72 days
B) 20.08 days
C) 21.88 days
D) 18.47 days
E) 22.09 days
Answer: C
Explanation: ACP = .34(10) + .66(28)
ACP = 21.88 days
Bloom's: Apply
47) Lemoyne mailed an invoice today in the amount of $1,268 with terms of 2/7 net 30. What is
the cost of credit to the customer if they pay on the last day of the credit period? Assume a 365-
day year.
A) 41.02 percent
B) 39.62 percent
C) 37.80 percent
D) 37.56 percent
E) 39.40 percent
Answer: C
Explanation: Rate for 23 days = .02($1,268)/[(1 − .02)($1,268)]
Rate for 23 days = .020408
EAR = 1.020408(365/23) − 1
EAR = .3780, or 37.80%
Topic: Costs of credit
Bloom's: Analyze
AACSB: Analytical Thinking
17
48) Jaxon Markets currently has credit terms of net 30, an average collection period of 29 days,
and average receivables of $211,410. The firm estimates that if it offered terms of 2/10, net 30
that 45 percent of its customers would pay on Day 10 with the remainder paying on average in
32 days. How much cash could the company free up from its accounts receivables if it switched
its credit policy?
A) $38,762
B) $50,301
C) $64,219
D) $58,336
E) $65,009
Answer: B
Explanation: Average daily sales = Accounts receivable/Average collection period
Average daily sales = $211,410/29
Average daily sales = $7,290.
New average collection period = .45(10) + .55(32)
New average collection period = 22.10 days
New accounts receivable = Average daily sales (Average collection period)
New accounts receivable = $7,290(22.10)
New accounts receivable = $161,109
Cash freed up = Old accounts receivable − New accounts receivable
Cash freed up = $211,410 − 161,109
Cash freed up = $50,301
Topic: Credit terms
Bloom's: Analyze
18
49) Yesterday, Smiley Company sold $22,500 of merchandise on credit. The invoice was sent
today with the terms, 3/10 net 40. This customer normally pays on the net date. What is the
effective rate of interest the customer is paying by not taking the discount? Assume a 365-day
year.
A) 42.31 percent
B) 44.86 percent
C) 39.27 percent
D) 40.54 percent
E) 45.38 percent
Answer: B
Explanation: Rate for 30 days = .03($22,500)/[(1 − .03)($22,500)]
Rate for 30 days = .030928
EAR = 1.030928(365/30) − 1
EAR = .4486, or 44.86%
Topic: Costs of credit
Bloom's: Analyze
50) Edgeworth Co. has an all-cash policy and sells 50 units per month at $920 a unit. The
variable cost is $700 a unit. Should the firm grant 30 days of credit, it expects its sales would rise
to 60 units without changes to price or costs per unit. The monthly required return is .75 percent.
What is the NPV of switching to a credit policy?
A) $266,667
B) $346,333
C) $366,667
D) $240,333
E) $258,778
Answer: D
Explanation: NPV of switching = −[PQ + v(Q' − Q)] + [(P − v)(Q' − Q)]/R
NPV of switching = −[$920(50) + $700(60 − 50)] + [($920 − 700)(60 − 50)]/.0075
NPV of switching = $240,333
Bloom's: Analyze
19
51) Assume Atlantic Fish sells 3,200 pounds of fish per month at a price of $2.90 a pound. The
variable cost per pound is $2.22. Currently, the firm has a cash-only sales policy. The firm is
considering changing to a net 30 credit policy. The monthly required return is 1.2 percent. What
does the new level of sales need to be to break even on the switch?
A) 3,219.40 pounds
B) 3,489.67 pounds
C) 3,370.44 pounds
D) 170.44 pounds
E) 119.40 pounds
Answer: C
Explanation: NPV = −[PQ + v(Q' − Q)] + [(P − v)(Q' − Q)]/R
0 = −[$2.90(3,200) + $2.22(Q' − Q)] + [($2.90 − 2.22)(Q' − Q)]/.012
Q' − Q = 170.44 pounds
Q' = Q + (Q' − Q)
Q' = 3,200 + 170.44
Q' = 3,370.44
Bloom's: Analyze
52) Lewis Companies sells 2,600 units a month for cash at a price of $299 a unit and a variable
cost of $187 a unit. The firm estimates it can increase its sales by 200 units a month if it switches
to a net 30 credit policy while keeping its price and costs at their current levels. If the monthly
cost of capital is .85 percent, what is the NPV of switching?
A) $1,590,005
B) $1,394,008
C) $1,211,036
D) $1,820,494
E) $2,006,413
Answer: D
Explanation: NPV = −[PQ + v(Q' − Q)] + [(P − v)(Q' − Q)]/R
NPV = −[$299(2,600) + $187(200)] + [($299 − 187)(200)]/.0085
NPV = $1,820,494
Bloom's: Analyze
20
53) Underwood United has been approached by a new customer who has asked the firm to
extend credit for 30 days on a one-time purchase of $499. The firm's required return on
receivables is 1.8 percent per month and the variable cost of the desired item is $327. What is the
NPV of granting credit if the firm estimates the probability of default is 15 percent?
A) $62.93
B) $108.40
C) $89.65
D) $94.15
E) $76.67
Answer: C
Explanation: NPV = −v + (1 − π)P/(1 + R)
NPV = −$327 + (1 − .15)$499/1.018
NPV = $89.65
Bloom's: Analyze
54) Alexander Moore & Co. is willing to offer credit on a one-time purchase provided the NPV
of the transaction is at least $50 at a required monthly return of 2 percent. Assume a potential
sale has a sales price of $248 and a variable cost of $164. What is the maximum probability of
default that will result in an acceptable offer?
A) 32.55 percent
B) 29.62 percent
C) 11.98 percent
D) 10.02 percent
E) 18.50 percent
Answer: C
Explanation: NPV = −v + (1 − π)P/(1 + R)
$50 = −$164 + (1 − π)$248/1.02
π = .1198, or 11.98%
Bloom's: Analyze
21
55) A&M Hardware assumes new customers will default 8 percent of the time but if they don't
default, they will become repeat customers who always pay their bills. Assume the average sale
is $383 with a variable cost of $260, and a monthly required return of 1.65 percent. What is the
NPV of extending credit for one month to a new customer?
A) $5,589.09
B) $6,103.47
C) $6,598.18
D) $5,748.09
E) $6,858.18
Answer: C
Explanation: NPV = −v + (1 − π)(P − v)/R
NPV = −$260 + (1 − .08)($383 − 260)/.0165
NPV = $6,598.18
Bloom's: Analyze
56) Neilson's is a new firm that sells a product with a variable cost of $62 a unit. The firm has a
monthly required return of 1.8 percent. The firm wants to offer all new customers 30 days of
credit and expects that if it does so, that 12 percent will default on payment while the others
become repeat customers. What is the minimum price the firm could charge to break-even on an
NPV basis?
A) $82.15
B) $74.09
C) $63.27
D) $98.14
E) $78.40
Answer: C
Explanation: NPV = −v + (1 − π)(P − v)/R
0 = −$62 + (1 − .12)(P − $62)/.018
P = $63.27
Bloom's: Analyze
22
57) Sisler's sells 382,000 units a year and orders 10,000 units at a time. The cost of placing an
order is $24.90. What is the firm's annual total restocking cost?
A) $909.09
B) $984.23
C) $951.18
D) $1,023.02
E) $811.19
Answer: C
Explanation: Total restocking cost = Fixed cost per order (Number of orders)
Total restocking cost = $24.90(382,000/10,000)
Total restocking cost = $951.18
Bloom's: Analyze
58) Jensen's Boat Works total costs of holding inventory is $8,400 when its order sizes are
optimized. If the firm places 46 orders a year, what is the fixed cost per order?
A) $106.87
B) $101.15
C) $91.30
D) $87.62
E) $79.08
Answer: C
Explanation: At the optimal order size, carrying costs equal restocking costs. Thus, restocking
costs equal 50 percent of the total costs of holding inventory.
Total restocking cost = .50(Total costs) = Fixed cost per order (Number of orders)
Fixed cost per order = .50($8,400)/46
Fixed cost per order = $91.30
Bloom's: Analyze
23
59) Fried Onions has total annual sales of 438,000 units, a carrying cost per unit of $2.67 per
year, and restocking costs of $48 per order. What is the EOQ?
A) 4,203 units
B) 3,824 units
C) 3,968 units
D) 4,126 units
E) 4,511 units
Answer: C
Explanation: Q* = (2TF/CC).5
Q* = [2(438,000)($48)/$2.67].5
Q* = 3,968 units
Bloom's: Analyze
60) Baked Potatoes has total annual sales of 846,000 units, a carrying cost per unit of $1.64 per
year, and restocking costs of $31 per order. Each inventory item has an average cost of $2.39.
What is the average dollar value of the firm's inventory if it always orders the most economical
quantity?
A) $6,758
B) $7,008
C) $7,409
D) $6,218
E) $6,411
Answer: A
Explanation: Q* = (2TF/CC).5
Q* = [2(846,000)($31)/$1.64].5
Q* = 5,655 units
Average inventory value = (Q*/2)(Cost per unit)
Average inventory value = (5,655/2)($2.39)
Average inventory value = $6,758
Bloom's: Analyze
24
61) Identify several factors that affect the length of the credit period and provide an explanation
of each.
Answer: The length of the credit period is affected by:
∙ Perishability and collateral value: The credit period should be less than the life of the item
being financed. For example, if bananas have a shelf life of one-week then the credit period
should probably be one week or less.
∙ Consumer demand: The credit period should be inversely related to consumer demand. In
other words, the higher the demand, the shorter the credit period.
∙ Cost, profitability, and standardization: The greater the standardization and the lower the
cost, generally the shorter the credit period.
∙ Credit risk: As with any risk, the less exposure to it the better. Thus, the higher the risk, the
shorter the credit period.
∙ Size of the account: The larger the account size the longer the credit period that may be
granted, especially if an account represents a significant portion of a firm's sales.
∙ Competition: In a competitive market, credit periods may be extended as a means of gaining
sales.
∙ Customer type: The type of customer and their operating cycle will influence the credit
period. Some sellers are willing to finance a buyer's inventory period and maybe even its
accounts receivable period, but not beyond.
Topic: Credit terms
Bloom's: Apply
62) Green Garden is a cash-only company. The company is considering switching to a 30-day
credit policy with no discounts. What factors should the firm consider before making the switch?
Answer: The firm should consider the price it can charge for credit sales, any anticipated
changes in sales quantity, and the delay of one-month in collections. There is also no guarantee
that payment will ever be received. The firm must also consider their product costs which will
still be incurred prior to sale. With the delay in collections and potential need for additional
inventory the firm must consider its financing costs as its cash cycle will increase.
Bloom's: Apply
25
63) Uptown Markets recently did an analysis of its credit policy and considered several different
options. Once the analysis was completed and reviewed, the firm adopted the most optimal
policy. The president then stated: "Now, that's done. So we don't ever have to go through that
process again." Do you agree? Justify your answer.
Answer: You should not agree. The optimal credit policy and the NPV of any policy are based
on variables such as carrying and opportunity costs that can, and do, change over time.
Therefore, credit policy analysis should be considered an on-going process rather than a one-time
event.
Bloom's: Apply
64) There are generally considered to be five key factors that should be evaluated when trying to
determine if a customer will pay. Write five questions that a credit manager should answer when
reviewing a credit application that would address these factors.
Answer: Here is one set of sample questions:
∙ Character: Is the customer willing to pay his/her bills?

∙ Capacity: Does the customer have sufficient cash flow to be able to pay his/her bills?
∙ Capital: Does the customer have sufficient financial assets to support this debt?
∙ Collateral: Does the customer have assets, either the item being purchased, or other items, of
sufficient value that could be sold to repay this debt?
∙ Conditions: Is the economic and business outlook for the customer's business favorable for
the repayment of the customer's debts?
Bloom's: Apply
26
65) Explain how inventory is managed under an ABC inventory system.
Answer: With an ABC system the items that represent the largest percentage of inventory value
are classified as "A" items. Because of their cost, these items are monitored closely and
purchased primarily as needed, with minimal, if any, units kept as extra stock. Items of low value
are classified as "C" items. These tend to be basic commodity items that are bought in bulk and
kept on hand at all times. "B" items fall between these two extremes and are managed
accordingly.
Topic: ABC inventory management
Bloom's: Apply
66) Explain the purpose of a safety stock and how this relates to reorder points.
Answer: Safety stock is the term used for the minimum level of inventory that a firm keeps on
hand. This stock is available to the firm should an inventory order be delayed or an unexpected
increase in production arise. Reorder points are set at a level such that the ordered inventory
should arrive just as the inventory is reduced to its safety stock level. Thus, by determining when
inventory will fall to the safety stock level and then backing out the order delivery time, the
reorder points can be identified.
Bloom's: Apply
27

Chapter 28 Credit and Inventory Management: Corporate Finance, 12e (Ross)

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Chapter 28 Credit and Inventory Management: Corporate Finance, 12e (Ross)

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Corporate Finance, 12e (Ross)

Chapter 28 Credit and Inventory Management

1) Selling goods and services on credit is:

3) The average collection period measures the average:

5) Credit analysis is best described as the process of:

8) The credit period begins on the:

11) Seasonal dating of accounts receivable:

14) Cash discounts:

16) Which one of these statements is true regarding promissory notes?

17) A commercial draft typically:

19) One characteristic of a conditional sales contract is that the:

34) All of these are carrying costs of inventory except:

38) The EOQ model assumes inventory:

40) The total restocking cost is calculated as:

43) For a JIT inventory system to be efficient, the:

Answer: The length of the credit period is affected by:

Answer: Here is one set of sample questions:

∙ Character: Is the customer willing to pay his/her bills?

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