Chapter 021 Credit and Inventory Management
Multiple Choice Questions
1. The conditions under which a firm sells its goods and services for cash or credit are
called the:
A. terms of sale.
b. credit analysis.
c. collection policy.
d. payables policy.
e. collection float.
SECTION: 21.1
TOPIC: TERMS OF SALE
TYPE: DEFINITIONS
2. The process of determining the likelihood that customers will not pay is called:
a. the terms of sale.
B. credit analysis.
c. the collection policy.
d. the payables policy.
e. disbursement analysis.
SECTION: 21.1
TOPIC: CREDIT ANALYSIS
TYPE: DEFINITIONS
3. The procedures a firm follows in the pursuit of customer payments are referred to as the
firm's _____ policy.
a. sales
b. credit
C. collection
d. payables
e. disbursements
SECTION: 21.1
TOPIC: COLLECTION POLICY
TYPE: DEFINITIONS
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Chapter 021 Credit and Inventory Management
4. The length of time for which credit is granted to a firm's customers is called the:
a. payables period.
b. operating cycle.
c. transactions period.
D. credit period.
e. disbursement period.
SECTION: 21.2
TOPIC: CREDIT PERIOD
TYPE: DEFINITIONS
5. The bill for goods or services provided by the seller to the purchaser is called a(n):
a. ledger statement.
b. warranty.
c. indenture.
d. indemnity statement.
E. invoice.
SECTION: 21.2
TOPIC: INVOICE
TYPE: DEFINITIONS
6. A discount given to buyers as an inducement for prompt payment is called a(n) _____
discount.
A. cash
b. purchase
c. collection
d. market
e. receivables
SECTION: 21.2
TOPIC: CASH DISCOUNT
TYPE: DEFINITIONS
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Chapter 021 Credit and Inventory Management
7. The basic evidence of indebtedness is called the:
a. account document.
b. sales draft.
C. credit instrument.
d. commercial paper.
e. letter of debt.
SECTION: 21.2
TOPIC: CREDIT INSTRUMENT
TYPE: DEFINITIONS
8. A graphical representation of the sum of the carrying costs and the opportunity costs of
a chosen credit policy is called the:
a. opportunity cost curve.
b. credit extension curve.
C. credit cost curve.
d. terms of sale graph.
e. economic order quantity graph.
SECTION: 21.4
TOPIC: CREDIT COST CURVE
TYPE: DEFINITIONS
9. A captive finance company is:
A. a wholly-owned subsidiary that handles the credit function for the parent firm.
b. controlled disbursements company which controls the accounts payables for the parent
firm.
c. a wholly-owned subsidiary which handles all the long-term debt obligations of the
parent firm.
d. a loan company which provides financing strictly to a particular industry, such as retail
furniture stores.
e. a consumer loan company which operates in one clearly defined and limited geographic
area.
SECTION: 21.4
TOPIC: CAPTIVE FINANCE COMPANY
TYPE: DEFINITIONS
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Chapter 021 Credit and Inventory Management
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.
SECTION: 21.5
TOPIC: FIVE Cs OF CREDIT
TYPE: DEFINITIONS
11. What is the process of quantifying the likelihood of default when granting consumer
credit called?
A. credit scoring
b. credit capacity
c. receipts assessment
d. conditions for credit
e. consumer analysis
SECTION: 21.5
TOPIC: CREDIT SCORING
TYPE: DEFINITIONS
12. A compilation of a firm's accounts receivables segmented by the length of time each
account has remained unpaid is called a(n):
a. credit report.
B. aging schedule.
c. risk assessment report.
d. turnover delineation.
e. receivables consolidation and consistency report.
SECTION: 21.6
TOPIC: AGING SCHEDULE
TYPE: DEFINITIONS
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Chapter 021 Credit and Inventory Management
13. What is the restocking quantity that minimizes a firm's total inventory cost called?
a. short order quantity
b. refill unit quantity
C. economic order quantity
d. minimum stock level
e. re-order limit
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY
TYPE: DEFINITIONS
14. The procedures used to determine inventory levels for demand-dependent inventory
types such as work-in-progress and raw materials are called:
a. first-in, first-out methods.
b. the Baumol model.
c. net working capital planning.
d. economic order procedures.
E. materials requirements planning.
SECTION: 21.8
TOPIC: MATERIALS REQUIREMENTS PLANNING
TYPE: DEFINITIONS
15. Which one of the following is a system for managing demand-dependent inventories
that minimizes the inventory holdings of a firm?
A. just-in-time inventory
b. turnover planning
c. net working capital planning
d. inventory scoring
e. inventory ranking
SECTION: 21.8
TOPIC: JUST-IN-TIME INVENTORY
TYPE: DEFINITIONS
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Chapter 021 Credit and Inventory Management
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
SECTION: 21.1
TOPIC: TERMS OF SALE
TYPE: CONCEPTS
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
SECTION: 21.1
TOPIC: CREDIT ANALYSIS
TYPE: CONCEPTS
18. The period of time which extends from the day a credit sale is made until 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. credit
SECTION: 21.1
TOPIC: ACCOUNTS RECEIVABLE PERIOD
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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
SECTION: 21.1
TOPIC: INVESTMENT IN RECEIVABLES
TYPE: CONCEPTS
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.
SECTION: 21.1
TOPIC: INVESTMENT IN RECEIVABLES
TYPE: CONCEPTS
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
SECTION: 21.1
TOPIC: INVESTMENT IN RECEIVABLES
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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.
SECTION: 21.2
TOPIC: TERMS OF SALE
TYPE: CONCEPTS
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
SECTION: 21.2
TOPIC: TERMS OF SALE
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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 do not plan on taking advantage of the discount?
a. store A
b. store B
c. store C
D. store D
e. store E
SECTION: 21.2
TOPIC: TERMS OF SALE
TYPE: CONCEPTS
25. Which one of the following statements is correct concerning the credit period?
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.
SECTION: 21.2
TOPIC: CREDIT PERIOD
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
26. Which two of the following are the key considerations when setting the length of the
credit period for 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
SECTION: 21.2
TOPIC: CREDIT PERIOD
TYPE: CONCEPTS
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
SECTION: 21.2
TOPIC: CREDIT PERIOD
TYPE: CONCEPTS
28. Which one of the following statements is correct concerning 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. A firm may offer different credit terms to different customers.
e. Newer products tend to have shorter credit periods.
SECTION: 21.2
TOPIC: CREDIT PERIOD
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
29. A cash discount of 3/15, net 45:
a. grants customers 45 days to pay after the discount period expires.
b. discourages customers from paying early.
c. grants free credit for a period of 45 days.
d. charges higher prices if a customer pays cash at the time of purchase.
E. grants customers 45 days to pay if they forfeit the discount.
SECTION: 21.2
TOPIC: DISCOUNTS
TYPE: CONCEPTS
30. Under credit terms of 2/10, net 25, customers should:
a. always pay on the 25th day.
b. take the 10 percent discount and pay immediately.
c. take the discount and pay on the 2nd day.
D. either take the discount or pay on the 25th day.
e. both take the discount and pay on the 25th day.
SECTION: 21.2
TOPIC: DISCOUNTS
TYPE: CONCEPTS
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 everyone takes the
discount.
d. tends to have little effect on the seller's collection period due to the high effective
interest rate.
e. tends to increase a firm's investment in receivables as compared to a straight net 30
policy.
SECTION: 21.2
TOPIC: COST OF CREDIT
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
32. Tressler's offers trade discount with terms of 2/5, EOM. When are invoices with these
terms due?
a. Invoices are due on the last day of the month in which the purchase occurred.
b. Invoices are due on the last day of the month following the month of purchase.
c. Invoices are due five days after the purchase date.
D. Invoices are due on the 5th of the month following the month of purchase.
e. Invoices are due on the 5th of the month following the month of purchase if you want
the discount, otherwise, the invoices are due at the end of the month following the month
of purchase.
SECTION: 21.2
TOPIC: TRADE DISCOUNT
TYPE: CONCEPTS
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
SECTION: 21.2
TOPIC: CREDIT INSTRUMENTS
TYPE: CONCEPTS
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.
SECTION: 21.2
TOPIC: CREDIT INSTRUMENTS
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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 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
SECTION: 21.3
TOPIC: CREDIT POLICY EFFECTS
TYPE: CONCEPTS
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.
SECTION: 21.3
TOPIC: EVALUATING CREDIT POLICY
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
37. The optimal amount of credit would equate 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.
SECTION: 21.4
TOPIC: OPTIMAL AMOUNT OF CREDIT
TYPE: CONCEPTS
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.
SECTION: 21.4
TOPIC: OPTIMAL CREDIT POLICY
TYPE: CONCEPTS
39. If you extend credit to a one-time 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.
SECTION: 21.5
TOPIC: CREDIT ANALYSIS
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
40. Which one of the following statements is correct?
a. If the majority of your 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 is not indicative of their future payment history.
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
you are willing to ever extend to that customer as their initial credit limit.
SECTION: 21.5
TOPIC: CREDIT ANALYSIS
TYPE: CONCEPTS
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
SECTION: 21.5
TOPIC: CREDIT INFORMATION
TYPE: CONCEPTS
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.
SECTION: 21.5
TOPIC: FIVE Cs OF CREDIT
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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
SECTION: 21.5
TOPIC: FIVE Cs OF CREDIT
TYPE: CONCEPTS
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
SECTION: 21.5
TOPIC: FIVE Cs OF CREDIT
TYPE: CONCEPTS
45. Which one of the following statements is correct?
A. An aging schedule helps identify which customers are the most delinquent.
b. The percentage of total receivables that fall 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.
SECTION: 21.6
TOPIC: COLLECTION POLICY
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
46. Which one of the following inventory items is probably the least liquid?
a. bricks held in inventory by a home builder
b. a garden tractor held in inventory by a home improvements retail outlet
C. a partially assembled motor for a tractor
d. cut logs owned by a timber mill
e. satellite radio systems held in inventory by a car manufacturer
SECTION: 21.7
TOPIC: INVENTORY TYPES
TYPE: CONCEPTS
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. corn held in a storage facility
d. customized drilling press
e. a partially built new home
SECTION: 21.7
TOPIC: INVENTORY TYPES
TYPE: CONCEPTS
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
SECTION: 21.7
TOPIC: INVENTORY COSTS
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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.
SECTION: 21.8
TOPIC: INVENTORY MANAGEMENT TECHNIQUES
TYPE: CONCEPTS
50. The economic order quantity 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 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.
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: CONCEPTS
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. the total costs equal the carrying costs.
E. the carrying costs equal the restocking costs.
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
52. The economic order quantity 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.
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: CONCEPTS
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. steering wheels used by an auto manufacturer
c. shoes on display in a retail store
d. toys ready to be shipped to toy stores
e. wheat harvested by a farmer
SECTION: 21.8
TOPIC: DERIVED-DEMAND INVENTORY
TYPE: CONCEPTS
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.
SECTION: 21.8
TOPIC: DERIVED-DEMAND INVENTORY
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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
SECTION: 21.8
TOPIC: JUST-IN-TIME INVENTORY
TYPE: CONCEPTS
56. The incremental investment in receivables under the accounts receivable approach is
equal to:
a.
b.
C.
d.
e.
SECTION: 21.A
TOPIC: ACCOUNTS RECEIVABLE APPROACH
TYPE: CONCEPTS
57. The accounts receivable approach supports the theory that:
A. your risk of offering credit to a new customer is limited to your cost of the items sold.
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.
SECTION: 21.A
TOPIC: ACCOUNTS RECEIVABLE APPROACH
TYPE: CONCEPTS
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Chapter 021 Credit and Inventory Management
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, II, and IV only
e. II, III, and IV only
SECTION: 21.A
TOPIC: NPV OF SWITCH
TYPE: CONCEPTS
59. On average your firm sells $26,500 of items on credit each day. Your average
operating cycle is 51 days and your firm acquires and sells inventory on average every 19
days. What is your average accounts receivable balance?
a. $503,500
B. $848,000
c. $1,012,500
d. $1,315,500
e. $1,855,000
Accounts receivable balance = $26,500
(51
19) = $848,000
AACSB TOPIC: ANALYTIC
SECTION: 21.1
TOPIC: ACCOUNTS RECEIVABLE BALANCE
TYPE: PROBLEMS
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60. You just purchased $8,700 of goods from your supplier with credit terms of 3/10, net
30. What is the discounted price?
a. $6,090
b. $6,960
c. $7,830
D. $8,439
e. $8,911
Discounted price = $8,700
(1
.03) = $8,439
AACSB TOPIC: ANALYTIC
SECTION: 21.2
TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS
TYPE: PROBLEMS
61. Today, August 5, Solomon, Inc. bought $22,000 worth of merchandise from a
supplier. The credit terms are 2/8, net 25. By what day does Solomon, Inc. have to make
the payment to receive the discount?
a. August 7
B. August 13
c. August 22
d. August 28
e. August 30
End of discount period = August 5 + 8 days = August 13
AACSB TOPIC: ANALYTIC
SECTION: 21.2
TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS
TYPE: PROBLEMS
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62. Your supplier grants you credit terms of 2/10, net 35. What is the effective annual rate
of the discount if you purchase $2,900 worth of merchandise?
a. 23.5 percent
b. 27.7 percent
c. 28.8 percent
d. 33.5 percent
E. 34.3 percent
Days in period = 35 10 = 25; Periods per year = 365 / 25 = 14.6; Interest rate for 30
days = [.02 $2,900] / [(1 .02) $2,900] = $58 / $2,842 = .02041; Effective annual
rate = (1 + .02041)14.6 1 = .3431 = 34.3 percent
AACSB TOPIC: ANALYTIC
SECTION: 21.2
TOPIC: ACCOUNTS RECEIVABLE DISCOUNTS
TYPE: PROBLEMS
63. Your firm currently sells 500 units a month at a price of $75 a unit. You think you can
increase your sales by an additional 130 units if you switch to a net 30 credit policy. The
monthly interest rate is .4 percent and your variable cost per unit is $35. What is the
incremental cash inflow from the proposed credit policy switch?
a. $1,800
b. $2,400
c. $3,600
D. $5,200
e. $6,000
Incremental cash flow = ($75
$35)
130 = $5,200
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: CREDIT POLICY SWITCH
TYPE: PROBLEMS
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64. Your firm currently sells 215 units a month at a price of $90 a unit. You think you can
increase your sales by an additional 45 units if you switch to a net 30 credit policy. The
monthly interest rate is .5 percent and your variable cost per unit is $60. What is the net
present value of the proposed credit policy switch?
A. $247,950
b. $250,650
c. $255,050
d. $267,300
e. $274,350
NPV = -[($90
215) + ($60
45)] + [($90 - $60)
45] / .005 = $247,950
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: CREDIT POLICY SWITCH
TYPE: PROBLEMS
65. Currently, your firm sells 170 units a month at a price of $140 a unit. You think you
can increase your sales by an additional 30 units if you switch to a net 30 credit policy.
The monthly interest rate is .6 percent and your variable cost per unit is $100. What is the
net present value of the proposed credit policy switch?
A. $173,200
b. $187,200
c. $190,200
d. $197,000
e. $200,000
NPV = -[($140
170) + ($100
30)] + [($140
$100)
30] / .006 = $173,200
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: CREDIT POLICY SWITCH
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
66. Currently, Tyler Enterprises sells 350 units a month at a price of $42 a unit. The
company thinks they can increase sales by an additional 100 units if they switch to a net
30 credit policy. The monthly interest rate is .4 percent and the variable cost per unit is
$22. What is the incremental cash inflow of the proposed credit policy switch?
a. $1,480
B. $2,000
c. $2,200
d. $2,520
e. $4,200
Incremental cash flow = ($42
$22)
100 = $2,000
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: CREDIT POLICY SWITCH
TYPE: PROBLEMS
67. Your company currently sells a product with a variable cost per unit of $16 and a unit
selling price of $31. At the present time, your company only sells on a cash basis and has
monthly sales of 310 units. The monthly interest rate is 2 percent. Your company is
considering switching to a net 30 credit policy. What is the switch break-even point?
a. 312 units
b. 316 units
c. 320 units
D. 323 units
e. 329 units
Switch break-even point = Q¢ 310 = ($31
= 13 units; Q¢ = 310 + 13 = 323 units
310) / {[($31
$16) / .02]
$16} = 13.09
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: SWITCH BREAK-EVEN POINT
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
68. The Gardeners Co. currently sells 1,800 units a month for total monthly sales of
$79,200. The company is considering replacing its current cash only credit policy with a
net 30 policy. The variable cost per unit is $34 and the monthly interest rate is 1.7 percent.
What is the switch break-even level of sales?
A. 1,943 units
b. 2,017 units
c. 2,108 units
d. 2,406 units
e. 2,548 units
Switch break-even point = Q¢ 1,800 = ($79,200) / {[(($79,200 / 1,800) - $34) / .017] $34} = 142.90 = 143 units; Q¢ = 143 + 1,800 = 1,943 units
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: SWITCH BREAK-EVEN POINT
TYPE: PROBLEMS
69. Stamford, Inc. currently sells 8,350 units a month for total monthly sales of $179,500.
The company is considering replacing its current cash only credit policy with a net 30
policy. The variable cost per unit is $6.23 and the monthly interest rate is 2 percent. What
is the switch break-even level of sales?
a. 8,416 units
b. 8,517 units
C. 8,587 units
d. 8,606 units
e. 8,686 units
Switch break-even point = Q¢ 8,350 = ($179,500) / {[(($179,500 / 8,350) - $6.23) / .02]
- $6.23} = 237.08 = 237 units; Q¢ = 237 + 8,350 = 8,587 units
AACSB TOPIC: ANALYTIC
SECTION: 21.3
TOPIC: SWITCH BREAK-EVEN POINT
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
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 20 percent chance this person will never pay you. The
sales price of the item the customer wants to buy is $136. Your variable cost on that item
is $94 and your monthly interest rate is 2.5 percent. Should you grant credit to this
customer? Why or why not?
A. yes; because the net present value of the potential sale is $12
b. yes; because the net present value of the potential sale is $39
c. no; because the net present value of the potential sale is -$44
d. no; because the net present value of the potential sale is -$2
e. doesn't matter; because the NPV of the potential sale is zero
NPV = -$94 + (1 - .20)
[$136 / (1 + .025)] = $12.15 = $12
AACSB TOPIC: ANALYTIC
SECTION: 21.5
TOPIC: ONE-TIME SALE
TYPE: PROBLEMS
71. You are considering a temporary opening of a kiosk in the local mall. Any sale you
make will be a one-time sale. There is only a 45 percent chance that you will collect your
money on a credit sale. The product you want to sell has a variable cost of $4.10 and a
sales price of $5.75. The monthly interest rate is 1.3 percent. Should you offer people 30
days to pay? Why or why not?
a. yes; because you will earn $2.23 on every credit sale you make
b. yes; because you will earn $5.68 on every credit sale you make
c. no; because the net present value of the potential sale is -$1.55
D. no; because the net present value of the potential sale is -$.98
e. it doesn't matter; because the present value of the potential sale is $0
NPV = -$4.10 + (1
.45)
[$5.75 / (1 + .013)] = -$.98
AACSB TOPIC: ANALYTIC
SECTION: 21.5
TOPIC: ONE-TIME SALE
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
72. You are trying to attract new customers that you feel could become repeat customers.
The average price of the items you sell is $93 with a $70 variable cost. Your monthly
interest rate is 2.1 percent. Your experience tells you that 10 percent of these customers
will never pay their bill. What is the value of a new customer who does not default on their
bill?
a. $986
B. $1,095
c. $2,617
d. $3,333
e. $4,429
PV = ($93
$70) / .021 = $1,095.24 = $1,095
AACSB TOPIC: ANALYTIC
SECTION: 21.5
TOPIC: REPEAT SALE
TYPE: PROBLEMS
73. You are trying to attract new customers that you feel could become repeat customers.
The average price of the items you sell is $93 with a $70 variable cost. Your monthly
interest rate is 2.1 percent. Your experience tells you that 10 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 net present value of extending credit is $40
B. yes; because the net present value of extending credit is $916
c. no; because the net present value of extending credit is -$1,025
d. no; because the net present value of extending credit is -$59
e. it doesn't matter; because the present value of extending credit is $0
NPV = -$70 + (1
.10)
[($93
$70) / .021] = $915.71 = $916
AACSB TOPIC: ANALYTIC
SECTION: 21.5
TOPIC: REPEAT SALE
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
74. You sell 7,000 units of an item each year. The carrying cost per unit is $1.10 and the
fixed costs per order are $75. What is the economic order quantity?
a. 691 units
b. 713 units
c. 859 units
D. 977 units
e. 1,025 units
EOQ =
(2
7,000
$75) / $1.10 =
954,545.45 = 977.008 = 977 units
AACSB TOPIC: ANALYTIC
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: PROBLEMS
75. The most fashionable pair of roller skates sells for $45.99 a pair. Your store
consistently sells 8,500 pairs of these roller skates year after year. The fixed costs to order
more of this item is $70 and the carrying costs are $2.80 per pair. What is the economic
order quantity?
a. 184 units
b. 309 units
c. 461 units
d. 525 units
E. 652 units
EOQ =
(2
8,500
$70) / $2.80 =
425,000 = 651.92 = 652 units
AACSB TOPIC: ANALYTIC
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
76. One of the best selling items your firm offers sells for $19.99 a unit. The variable cost
per unit is $11.59 and the carrying cost per unit is $.58. You sell 10,415 of these units each
year. The fixed cost to order this item is $65. What is the economic order quantity?
a. 1,080 units
b. 1,314 units
C. 1,528 units
d. 1,773 units
e. 1,946 units
EOQ =
(2
10,415
$65) / $.58 =
2,334,396.55 = 1,527.87 = 1,528 units
AACSB TOPIC: ANALYTIC
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: PROBLEMS
77. Each year you sell 1,200 units of a product at a price of $59.99 each. The variable cost
per unit is $37.91 and the carrying cost per unit is $4.57. You have been buying 175 units
at a time. Your fixed cost of ordering is $80. What is the economic order quantity?
a. 185 units
b. 195 units
C. 205 units
d. 215 units
e. 225 units
EOQ =
(2
1,200
$80) / $4.57 =
42,013.13 = 204.97 = 205 units
AACSB TOPIC: ANALYTIC
SECTION: 21.8
TOPIC: ECONOMIC ORDER QUANTITY (EOQ)
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
78. Your firm currently has a cash sales only policy. Under this policy, you sell 290 units a
month at a price of $160 a unit. Your variable cost per unit is $104 and your carrying cost
per unit is $2.70. The monthly interest rate is 1.1 percent. You think that you can increase
your sales to 350 units a month if you institute a net 30 credit policy. What is the net
present value of the switch using the one-shot approach?
a. $228,400
b. $248,709
C. $252,814
d. $282,233
e. $285,902
Monthly benefit = [($160 350) / 1.011] ($104 350) [($160 $104) 290] =
$55,390.70 $36,400 $16,240 = $2,750.70; NPV of switch = $2,750.70 + ($2,750.70 /
.011) = $252,814
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: ONE-SHOT APPROACH
TYPE: PROBLEMS
79. Under your current cash sales only policy you sell 170 units a month at a price of $25.
Your variable cost per unit is $18 and your monthly interest rate is 2 percent. Based on a
recent survey, you believe that you can sell an additional 40 units per month if you offer a
net 30 credit policy. What is the net present value of the switch using the one-shot
approach?
a. $5,044
b. $6,970
c. $7,584
d. $8,853
E. $9,030
Monthly benefit = [($25 (170 + 40)) / 1.02] ($18 (170 + 40)) [($25 $18)
170] = $5,147.06 $3,780 $1,190 = $177.06; NPV of switch = $177.06 + ($177.06 /
.02) = $9,030
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: ONE-SHOT APPROACH
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
80. Under your current cash sales only policy you sell 110 units a month for a total sales
value of $7,590. Your variable cost per unit is $38 and your monthly interest rate is 1.7
percent. Based on a recent survey, you believe that you can sell an additional 30 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. $45,976
b. $47,116
c. $49,081
d. $50,224
e. $53,566
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: ACCOUNTS RECEIVABLE APPROACH
TYPE: PROBLEMS
81. You are currently selling 60 units a month at a price of $195 a unit. Your variable cost
of each unit is $145. 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 100 units per month. Your monthly
interest rate is 1.5 percent. What is the net present value of this proposed switch using the
accounts receivable approach?
A. $115,833
b. $126,667
c. $133,333
d. $145,667
e. $152,833
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: ACCOUNTS RECEIVALBE APPROACH
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
82. Your current sales consist of 25 units per month at a price of $200 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 $215 a unit. If you make the switch you do not expect your total monthly sales
quantity to change but you do expect a 2 percent default rate. The monthly interest rate is
2.5 percent. What is the net present value of the proposed credit policy switch?
a. $0
b. $5,000
C. $5,700
d. $10,000
e. $10,700
d = ($215 - $200) / $215 = .069767442
NPV = -($200 25) + {($215 25) [(.069767442 - .02) / .025]} = -$5,000 + $10,700
= $5,700
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: DISCOUNTS AND DEFAULT RISK
TYPE: PROBLEMS
83. Your current sales consist of 25 units per month at a price of $200 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 $215 a unit. The monthly interest rate is 2 percent. What is the break-even default
rate of the proposed switch?
a. 4.48 percent
b. 4.59 percent
c. 4.65 percent
d. 4.97 percent
E. 5.12 percent
d = ($215 $200) / $215 = .069767442;  = .069767442
.05116 = 5.12 percent
.02
(1
.069767442) =
AACSB TOPIC: ANALYTIC
SECTION: 21.A
TOPIC: DISCOUNTS AND DEFAULT RISK
TYPE: PROBLEMS
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Chapter 021 Credit and Inventory Management
Essay Questions
84. Which do you feel is the more appropriate upper limit for the credit period which 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.
AACSB TOPIC: REFLECTIVE THINKING
SECTION: 21.2
TOPIC: LENGTH OF CREDIT PERIOD
85. 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 or not is debatable, but this practice occurs fairly frequently.
AACSB TOPIC: REFLECTIVE THINKING AND ETHICS
SECTION: 21.2
TOPIC: ETHICS AND THE CREDIT PERIOD
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Chapter 021 Credit and Inventory Management
86. Why might firms forego discounts 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 they have inadequate cash flow to take them. 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 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, any of the cash and liquidity management
policies discussed earlier in the text would help the situation if the firm is able to enhance
its liquidity and cash flow.
AACSB TOPIC: REFLECTIVE THINKING
SECTION: 21.2
TOPIC: DISCOUNTS
87. All else equal, it is likely that firms with (1) excess capacity, (2) low variable costs,
and (3) repeat customers will extend credit more liberally than others. Why?
Firms with excess capacity will likely extend credit more liberally as a means to increase
sales and capacity usage. 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 their customers' character and credit needs, thereby
facilitating more liberal credit terms.
AACSB TOPIC: REFLECTIVE THINKING
SECTION: 21.4
TOPIC: LIBERAL CREDIT TERMS
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