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000
=J90 000 =300 tires
~ $1.60 ,
b. 12,000 tires/300 tires= 40 orders
c. EOQ/2 = 300/2 = 150 tires (average inventory)
I 3. Economic ordering quantity (LOS) Fisk Corporation is trying to improve its inventory
control system and has installed an online computer al its retai I stores. Fisk anticipates
s:Li es of 75,000 units per year, an ordering cos! of $8 per order, and carrying costs of $1.20
per unit.
a. What is the economic ordering quantity?
b. How many orders wi ll be placed doling the year?
c. Whal will the average inveolory be?
7-l l
d. What is the total cost of ordel.ing and carrying inventory?
7-13. Solution:
Fisk Corp.
a.
_ 2x75,000x$8 _
1
OOO .
- C -\ $1.20 - ' UllJtS
b. 75,000 units/1,000 units= 75 orders
c. EOQ/2 = 1,000/2 = 500 units (average inventory)
d. 75 orders x $8 ordering cost
500 units x $1.20 carrying cost per unit
Total costs
= $ 600
- 600
=$1,200
14. Economic ordering quantity (LOS) (See Problem 13 for basic data.) In the second year,
Fisk Corporation fi nds that it can reduce ordel.ing costs to $2 per order but that carrying
costs will stay the same at $1 .20. Also, volume remains at 75,000 units.
a. Recompute a, b, c, and d in Problem 13 for the second year.
b. Now compare years one and two and explain what happened.
7-14. Solution:
a.
Fisk Corp. (Continued)
EOQ = = 2x 75,000x$2
c \ $1.20
..., , $
300
000
= = 500 units
$1.20
75,000 units/500 units= 150 orders
EOQ/2 = 500/2 = 250 units (average inventory)
150 orders x $2 ordering cost = $300
7-t2
250 units x $1.20 carrying cost per unit
Total costs
= 300
=$600
b. The number of units ordered declines 50%, while the number
of orders doubles. The average inventory and total costs both
decline by one-half. Notice that the total cost did not decline
in equal percentage to the decline in ordering costs. This is
because the change in EOQ and other variables (V2) is
proportional to the square root of the change in ordering
costs ('A).
I 5. Economic. ordering quantity with safety stock {LOS) Diagtlostic Supplies has expected
sales of 135,000 units per year, carrying costs of $3 per unit, and an ordering cost of $4 per
order.
a. What is the economic order <JU<\ntity?
b. Whal is the average inventory? What is the total canying cosr?
c. Assume an additional 80 units of inventory wi ll be required as safety sLock. What will
the new average invenlory be? What will the new wtal caJTying cost be?
7-15. Solution:
a.
Diagnostic Supplies
= 2xl35, 000x$4
c .\ $3
$t,ogo,OOO = ..}$360 000 = 600 units
$3 ,
b. EOQ/2 = 600/2 = 300 units (average inventory)
300 units x $3 carrying cost/unit = $900 total carrying
cost
7- t 3
c. Average inventory= EOQ +Safety Stock
2
=
600
+80=300+80=380
2
380 inventory x $3 carrying cost per year
= $ 1,140 total carrying cost
16. Level versus seasonal production (LOS) Wisconsin Snowmobi le Corp. is considering a
switch 10 level production. Cost efliciencies would occur under level production, and
afte-rtax costs would decline by $30,000, but inventor)' would increase by $250,000.
Wisconsin Snowmobi le have 10 linance the extra inventory at a cost of 13.5 percent.
a. Should the company go ahead and switch to level production?
b. How low would interest rates need to f<tll before level production would be feasible?
7-16. Solution:
Wisconsin Snowmobile Corporation
a. Inventory increases by
x interest expense
Increased costs
Savings
Less: Increased costs
Loss
$250,000
13.5%
$ 33,750
$30,000
($33,750)
($ 3,750)
Don' t switch to level production.
b. If interest rates fall to 12% or less, the switch would be
feas ible.
7-t4
__ __c $_3_0.:...., O_O_O_S_a_v_in_, g"--s __ =
12
%
$250,000 increased invent01y
However, the deci sion is more complicated because it depends on
expectations for interest rates. If the extra inventory were considered
permanent current assets and was financed by locking in long-term
interest rates below 12%, then it would make sense to switch.
However, given that short-term rates are volatile; thi s decision can't
be made on a dip in short-term interest rates below 12%.
17. Credit policy decision (L04) Johnson ElectrOnics is considering extending trade credit to
some customers previously considered poor risks. Sales would increase by $100,000 if credit
is extended to these new customers. Of the new accounts receivable generated, I 0 percent will
prove to be uncollectible. Additional collection costs will be 3 percem of sales, and production
and selling costs will be 79 percent of sales. The (jrm is in the 40 percem tax bracket.
a. Compute the incremental income after taxes.
b. What will Johnson's incremental return on sales be if these new credit customers are
accepted?
c. U' the receivable turnover ratio is 6 to I, and no other asset buildup is needed to serve
the new customers, what will Johnson's incremental reiUrn on new average
investment be?
7-17. Solution:
Johnson Electronics
a. Additional sales ................................................... .
Accounts uncollectible (10% of new sales) ........ .
Annual incremental revenue ................ ............... .
Collection costs (3% of new sales) ..................... .
Production and selling costs
(79% of new sales) .......................... ....... ........ .
Annual income before taxes .... ...... ...................... .
Taxes (40%) .. ...................................................... .
Incremental income after taxes ........................... .
7 15
$100,000
- 10,000
$90,000
- 3,000
- 79,000
$ 8,000
3,200
$ 4,800
b.
Incremental income
Incremental retum on sales = --------
Incremental sales
= $4,800/$100,000 = 4.8%
c. Receivable tumover = Sales/Receivable turnover = 6x
Receivables = Sales/Receivable turnover
= $100,00016
= $ 16,666.67
Incremental return on new average investment
$4,800/$16,666.67 = 28.80%
18. Credit policy decision-recei vables and inventory ( L04 & 5) 1-lcodcrson Offi ce Supply
is considering a more Li beral credit policy to increase sales, but expects that 8 percent of the
new accounts will be uncollectible. Collection costs are 5 percent of new sales, production
and selling costs are 78 percent; and accounts receivable turnover is five li mes. Assume
income taxes of 30 percem and an increase in sales of $60,000. No other asset buildup will
be required 10 service the new accounts.
a. What is the level of accounts receivable to supporttllis sales expansion?
b. What would be Henderson's incremental aftertax retum on investment?
c. Should Henderson liberalize cmlit if lt 15 percent aftertax retum on investment is
required?
Assume that Henderson also needs to increase its level or inventory to support new sales and
that inventory turnover is four times.
d. What would be the total incremental investment in accounts receivable and inventory
10 support a $60,000 increase in sales'?
e. Gi ven the income determined in pan b and the investment determined in pan d,
should Henderson extend more liberal credit terms'?
7-18. Solution:
7-t6
Henderson Onice Supply
a. Investment in accoums receivable= $
60
000
= $12, 000
5
b. Added sa]es ......................................................... .
Accounts uncollectible (8% of new sales) .......... .
Annual incremental revenue .......... .................... ..
Collection costs (5% of new sales) .................... ..
Production and sel ling costs
(78% of new sales)
Annual income before taxes ................................ .
Taxes (30%) ........................................................ .
Incremental income after taxes .......................... ..
$60,000
- 4,800
$55,200
- 3,000
- 46,800
$ 5,400
- 1,620
$ 3,780
R
. I . $3,780 31 5m
etum on mcrementa mvestment = = . ro
J 2,000
7-18. (Continued)
c. Yes! 31.5% exceeds the required return of 15%.
d In
. . $60,000 $15 000
. vestment tn mvemory = = ,
Total incremental investment
Tnvemory
Accounts receivable
T ncremental investment
7- 17
4
$15,000
12,000
$27,000
$3,780/$27,000 = 14% return on investment
e. No! 14% is less than the required return of 15%.
J9. Credit policy dedsion with changi ng variables (L04) Comiskey Fence Co. is evaluating
the extension of credit to a new group of customers. Ahhough these customers will provide
$180,000 in additional cedit sale.s, 12 percent are likely to be uncollectible. The company
will also incur $ 15,700 in additional collection expense. Production and marketing costs
represent 70 percent of sales. The lirm is in a 34 percemtax bracket and has a receivables
turnover of five. times. No other asset buildup will be required to service the new
customers. The lirm has a 10 percent desired return.
a. Should Comiskey Fence Co. extend credit to these customers?
b. Should credit be extended if 15 percent of the new sales prove uncollectible?
c. Should credit be extended if the receivables turnover drops to 1.5, and 12 percent of
the accounts arc uncollectible (as in pan a)?
7-19. Solution:
Comiskey Fence Co.
a. Added sales ................................................... .......... $ 180,000
Accounts uncollectible (12% of new sales)............ 21,600
Annual incremental revenue................................... J 58,400
Collection costs............... ........ ................................ 15,700
Production and selling costs
(70% of new sales)......... ................... .. ....... ........... 126,000
Annual income before taxes .......... .............. ............ 16,700
Taxes (34%) ......................................... ............... .... 5,678
Incremental income after taxes .. . .. . .. . . .. . .. . . .. . .. .. ... ... . $ 11,022
$36,000 in
7-tS
R
. bl -0 $180,000
ecetva e turnover=:>. x = bl
5.0 new recetva es
R
. I . $11,022 30 62m
etum on mcrementa mvestment = = . . 7o
$36,000
Yes, extend credit to these customers since the incremental
return of 30.62% is greater than 10%.
7-19. (Continued)
b. Same as above except accounts uncollectible are $15% of
$180,000 or $27,000. This is $5,400 more than the value in
part a. This means a reduction in incremental income after
taxes of $3,564 to $7,458. The value can also be computed
as:
Added sales ................ ............................ ...... .. .... .. $180,000
Accounts uncollectible ( 15% of new sales)......... 27,000
Annual incremental revenue ................................ $153,000
Collection costs.................................................... 15,700
Production and selling costs
(70% of new sales) ..... .......................... ........ ...... .
Annual income before taxes ..................... ..... ...... .
Taxes (34%) ................................... .................... ..
Incremental income after taxes .. ........................ ..
126,000
J 1,300
3,842
$ 7,458
R
. tl . $
7
,4
58
20 72{)1
etum on mcrement< mvestment = = . 7o
$36,000
7-19
Yes, extend credit.
c. If receivable turnover drops to .1.5x, the investment in
accounts receivable would equal $180,000/1.5 = $120,000
instead of the $36,000 required in part a. The return on
incremental investment, assuming a 12% uncollectible rate,
is9.19%.
R
. a]. $11,022 9 19nf
eturn on mcrement mvestment = = . 7o
$120,000
The credit should not be extended. 9.19% is less than the
desired 10%.
20. Continuation of Problem 19 (L04) Reconsider problem 19C. Assume the average
collection period is 120 days. Al l other factors are the same (including 12 percent
uncollectibles). Should credit be extended?
7-20. Solution:
Comiskey Fence Company (Continued)
First compute the new accounts receivable balance.
Accounts receivable= average collection x average daily
period sales
$180,000
120 daysx = 120x$500 = $60,000
360 days
or
Accounts receivable= sales/accounts receivable turnover
. 360 days
Accounts recetvable twnover = = 3x
120 days
$ 180,000/3 = $60,000
7-20
Then compute return on incremental investment.
$ 11,022 =18.37%
$60,000
Yes, extend credit. 18.37% is greater than 10%.
21 . Cr edit policy and return on investment (L04) Global Services is considering a
promolional campaign 1ha1 will increase annual credit sales by $400,000. The company
will require investments in accoums receivable, inventory, and plam and equipmen1. The
mmover for each is as follows:
ACCOUDIS receivable ....... .... ... ......... ............. 4x
lnvemory ..................................................... 8x
Plam and equipment .................................... 2x
All $400,000 of the sales wil l be collectible. However, collection costs will be 4 percent of
sales, and produclion and sclli ug costs will be 76 pcrecnl of sales. The cost to carry
invemory will be 8 percent of invemory. DepreciaJion expense on plant and equipment will
be 5 percent of plant and equipment. The tax rale is 30 percent.
a. Compule the investments in ae<:otmts receivable, inventor)' , and pl:ml and equipment
based on the turnover raJios. Add the three LOge I her.
b. Compute the accoums receivable collection costs and production and selling costs
and add the two ligures together.
c. Compute lhe costs of carrying inventory.
d. Compute ihe depreciation expense on new plant and equipmenl.
e. Add together all the costs in pans b, c, and d.
f Subiract the answer from part e from Jhe sales fib'll re of $400,000 to arrive at income
before taxes. Subtract taxes ala rate of 30 percenl lo arrive at income after taxes.
g. Divide the aflenax return figure in partf by 1he total investment fi gure in pan a. If Jhe
fi rm has a required retum on investment of 12 percent, should it undertake I he
promotional campaign described throughout this problem.
7-21. Solution:
Global Services
a. Accounts receivable = sales/accounts receivable turnover
7-2 1
$100,000 = $400,000/4
Invemory = sales/inventory turnover
$50,000 = $400,000/8
Plant and equipment = sales/(plant and equipment turnover)
$200, 000 = $400, 000 I 2
$350,000 total investment
7-21. (Continued)
b. Collection cost = 4% x $400,000 $ 16,000
Production and selling costs = 76% x $400,000 = 304,000
Total costs related to accounts receivable $320,000
c. Cost of carrying inventory
8% x inventory
8% X $50,000
$4,000
d. Depreciation expense
5% X $200,000
$10,000
c. Total costs related to accounts receivable $320,000
Cost of carrying inventory
4,000
Depreciation expense
10,000
Total costs $334,000
f. Sales
$400,000
- total costs
334,000
Income before taxes 66,000
7-22
g.
Taxes (30%)
Income after taxes
Income after taxes = $46,200 =
13
.
2
%
Total investment 350,000
Yes, it should undertake the campaign.
19,800
$46,200
The aftertax return of 13.2% exceeds the required rate of
return of 12%.
22. Continuation of Problem (L04} In Problem 2 1, if turnover had only been 4 times:
a. What would be the new value for inventory invc..tmcnr>
b. What would be the return on invc>trncnt? You need to recompute the total investment
and the total costs of the campaign to work toward computing income after taxes.
Should the campaign be undenaken?
7-22. Solution:
Global Services (Continued)
a. Inventory = sales/inventory turnover
$100,000 = $400,000/4
b. New Total Investment
Accounts recei vable
inventory
Plant and equipment
$ 100,000
100,000
200,000
$400,000
Total Cost of the Campaign
Cost of carrying inventory
8% X $100,000 = $8,000
723
Sales
New Income After Taxes
$400,000
- lola! costs
Income before taxes
Taxes (30%)
Income after taxes
342,000
58,000
17,400
$40,600
($334,000 + $8,000
additional inventory
costs)
Return on inveslmenl
Income after taxes
Total investment
$40, 600 = 10.15%
400, 000
No, the campai gn should not be undertaken.
The after tax return of 10.15% is less than the required rate of
rerum of 12%.
(Problems 23-26 are t1 series and should be taken in order.)
23. Cr edit policy decision with changing variables (L04) Dome lliletals has credit sales of
$144,000 yearly with credi t terms of net 30 days, which is also the average collection
period. Dome does not offer a discount for earl y payment, so i ts customers take the full 30
days to pay. What is the avcrag" receivables balance? Receivables turnover?
7-23. Solution:
Dome Metals
Sales/360 days = average dai ly sales
$144,000/360 = $400
Accounts receivable balance = $400 x 30 days= $12,000
R
. bl Sales $144,000
12 eceJVa e turnover = = =
Receivables $12,000
or
7-24
360 days/30 = I 2x
24. If Dome offered a 2 percent discount for paymem in 10 days and eve.y customer took
advamage of the new terms, what would the new average receivables balance be? Use the
full sales of $ 144,000 for your calculation of receivables.
7-24. Solution:
$400 x I 0 days = $4,000 new receivable balance
25. If Dome reduces its bank loans, which cost 10 percent, by the cash generated from its
reduced receivables, what will be the net gaio or loss 10 the firm (don' t forget the 2
pcrccm)? Should it offer the d.iscount?
7-25. Solution:
Old receivables- new receivables
with discount
$12,000 $4,000
Funds freed by
di scount
= $8,000 discount
Savings on loan = LO% x $8,000 ........... . $ 800
(2,880)
$(2,080)
Discount on sales= 2% x $144,000 ....... .
Net change in income from discount ..... .
No! Don't offer the d.iscount since the income from reduced bank
loans does not offset the loss on the discount.
26. Assume that the new trade tcms of2110, net30 will increase sales by 15 percent because
the discount makes the Dome's p1ice competitive. lfDome earns 20 percent on sales before
discounts, should it offer the discount? (Consider the same variables as you did for
problems 23 through 25 as wi ll as increase sales.)
7-26. Solution:
7-25
New sales
Change in sales
Sales per day
Average receivables balance
I ncrease profit on new sales
Reduced profi t because
of discount
=$144,000x 1. 15 = $165,000
= $165,000 - $144,000 = $ 21,600
= $165,600/360 - $460
= $460 X J0 = $ 4,600
20% X $21,600 = $ 4,320
= 2% x $165,600 (3,312)
Savings in interest cost ($12,000 - $4,600) x 10% 740
Net change in income .. .................................. ....... . $ 1,748
Yes, offer the discount because total profit increases.
COMPREHENSIVE PROBLEM
Logan Oislri buling Company (receivables and invenlory policy) (LO 04 & 05) Log<\n
Distributing Company or Atlanta sells fans and heaters to retail omlets through out the Southeast.
Joe Logan, the president of the company, is thinki ng about changing the Finn's credit policy to
anract customers away from competitors. The present policy c:llls for a 1/10, n.et 30 cash
discount. The new policy would call for a 3/10, net 50 cash discount. Currently, 30 percent of
Logan customers are taking the discount, and it is amicipated that this number would go up to 50
percent with the new discoum policy. It is funher anticipated that annual sales would increase
from a level of $400,000 to $600,000 as a result of the change in the cash discount pol icy.
The increased sales would also a!Tect thc inventory level. The average inventory carried by
Logan is based on a determination of an EOQ. Assume sales of fans and heaters inc.ease from
15,000 to 22,500 units. The ordering cost for each order is $200 and the carrying cost per unit is
$1.50 (these values will not change with the discount). The average invemory is based on
EOQ/2. Each unit in invemory has an average cost of $12.
Cost of goods sold is equal to 65 percent of net sales: general and administrative expenses are
15 percent of net sales, and imerest payments of 14 percent will only be necessary for the
increase in the accounts receivable and inventory balance's. Taxes will be 40 percent of before-
tax income.
a. Compute the accounts receivable balance before and after the h ~ m g e in the cash
discount pol icy. Use the net sales (toUtl sales minus cash discounts) to determine the
'werage daily S(lles.
b. Detennine EOQ before and after the change in the cash discount policy. Translate this
into average inventory (in units and dollars) before and after the change in the casb
discount policy.
7-26
c. Complete the following income statement.
Net sales (Sales- Cash discounts) .............. .
Cost of goods sold ....................................... .
Gross protit ....... .... ......... ...... ....................... .
General and administrative expense ............ .
Operating profit ........................................... .
Interest on increase in accoums
receivable and invemory ( 14%) ............... .
Income before taxes ...................... .............. .
Taxes ...... ............ ...... ............... .... ................ .
Income after taxes ....................................... .
Befor e Policy
Change
d. Should the new cash discount policy be utilized? Brieny comment.
CP 7-1. Solution:
Logan Distributing Company
After Policy
Change
a. Accounts receivable= average collection x average daily
period sales
Before
Average collection period
.30 x LO days = 3
.70 x 30 days = 21
24 days (average ace. receivables)
Average daily sales
121
Credit sales- Discount _ $400,000 - (.OJ )(.30)($400,000)
-
360 days 360 days
-
$400,000 - $1,200
360days
$398,800
360days
Average daily sales = $1,107.78
Accounts recei vable= 24 days x $1, . 1 07.78 = $26,586.72
before policy change
After
Average collection period
.50 x 10 days = 5
.50 x 50 days = 25
30 days(avg. ace. receivables)
CP 7-1. (Continued)
Average daily sales
Credit sales - discounl _ $600,000- (.03) (.50)($600,000)
360 days 360 days
$600,000- $9, 000
360 days
$591,000
360 days
Average daily sales= $1,641.67
7-28
Accounts receivable= 30 days x $1,641 .67 = $49,250.10
after policy change
b. Before
EOQ = 2SO
c
2xl5,000x$200- $6,000,000 = /4 000 000 = 2 000 un.its
\ $1.50 . \ $1.50 " , , ,
After
2x22,000x$200 = $9,000,000 =
16
()()() OOO =
2 449
_
49
$1.50 ' $1.50 " , , ,
Average inventory
Before
2, 000 "] 000 .
---'--- = , umts
2
1,000 unitsx$12 = $12,000
7-29
CP 7-1. (Continued)
After
2,449.49 _ 1,224.75 units
2
or 1 ,225 (rounded)
1,224.75 units x$12 =
$14,697 or $14,700
(rounded)
c.
Before
Policy
Change
Net sales (sales- cash discount) $398,800
Cost of goods sold (65%) 259,220
Gross Profit 139,580
General and adm.in. expense
59,820
(15%)
Operating profit 79,760
*Interest on increase in accounts
receivable and inventory
(14%)
Income before taxes 79,760
Taxes (40%) 31,904
Income after taxes $ 47,856
*14%xAR = 14%x ($49,250. 10 - $26,586.72)
= 14%x$22,663.38
J4%x1NV =14%x ($14,697 -$12,000)
= 14%x$2.697
After
Policy
Change
$591,000
384,150
206,850
88,650
118,200
3,550.45
114,649.55
45,859.82
$ 68,789.73
=$3, 172.87
= $ 377.58
$3,550.45
d. The new cash discount policy should be util ized. The interest
cost on the increased accounts receivable and inventory is
730
small in comparison Lo Lhe increased operating profil from
the policy change.
7-31