CHAPTER 28—ADVANCED ISSUES IN CASH MANAGEMENT AND
INVENTORY CONTROL
TRUE/FALSE
1. The cash balances of most firms consist of transactions, compensating, precautionary, and speculative
balances. We can produce a total desired cash balance by calculating the amount needed for each
purpose and then summing them together.
2. The easier a firm’s access to borrowed funds the higher its precautionary balances will be, in order to
protect against sudden increases in interest rates.
3. For some firms, holding highly liquid marketable securities is a substitute for holding cash because a
marketable securities portfolio can accomplish the same objective as cash.
4. A just-in-time system is designed to stretch accounts payable as long as possible.
5. If a company increases its safety stock, then its EOQ will go up.
6. If a company increases its safety stock, then its average inventory will go up.
MULTIPLE CHOICE
7. Which of the following would cause average inventory holdings to decrease, other things held
constant?
a.
The purchase price of inventory items decreases by 50 percent.
b.
The carrying price of an item decreases (as a percent of purchase price).
c.
The sales forecast is revised downward by 10 percent.
d.
Interest rates fall.
e.
Fixed order costs double.
8. During times of inflation, which of these inventory accounting methods is best for cash flow?
a.
LIFO, because the most expensive goods are recorded as being sold first, resulting in a
higher cost of goods sold and a lower reported net income.
b.
Specific identification, because it correctly identifies the actual item sold and so the actual
cost is recorded on the income statement.
c.
Weighted average, because it smoothes the reported cost of goods sold over time.
d.
It doesn’t matter which you use since cash flow is unaffected by the choice of inventory
identification method.
e.
FIFO, because the cheapest goods are recorded as being sold first, resulting in lower cost
of goods sold and higher reported net income.
9. Which of the following is true of the Baumol model? Note that the optimal cash transfer amount is C*.
a.
If the total amount of cash needed during the year increases by 20%, then C* will increase
by 20%.
b.
If the average cash balance increases by 20%, then the total holding costs will increase by
20%.
c.
If the average cash balance increases by 20% the total transactions costs will increase by
20%.
d.
The optimal transfer amount is the same for all companies.
e.
If the fixed costs of selling securities or obtaining a loan (cost per transaction) increase by
20%, then C* will increase by 20%.
10. Which of the following is true of the EOQ model? Note that the optimal order quantity, Q, will be
called EOQ.
a.
If the annual sales, in units, increases by 20%, then EOQ will increase by 20%.
b.
If the average inventory increases by 20%, then the total carrying costs will increase by
20%.
c.
If the average inventory increases by 20% the total order costs will increase by 20%.
d.
The EOC is the same for all companies.
e.
If the fixed per order cost increases by 20%, then EOQ will increase by 20%.
11. Halliday Inc. receives a $2 million payment once a year. Of this amount, $700,000 is needed for cash
payments made during the next year. Each time Halliday deposits money in its account, a charge of
$2.00 is assessed to cover clerical costs. If Halliday can hold marketable securities that yield 5 percent,
and then convert these securities to cash at a cost of only the $2 deposit charge, what is the total cost
for one year of holding the minimum cost cash balance according to the Baumol model?
a.
$7,483
b.
$187
c.
$3,741
d.
$374
e.
$748
12. Humphrey’s Housing has been practicing cash management for some time by using the Baumol model
for determining cash balances. Some time ago, the model called for an average balance (C*/2) of $500;
at that time, the rate on marketable securities was 4 percent. A rapid increase in interest rates has
driven the interest rate up to 9 percent. What is the appropriate average cash balance now?
a.
$200
b.
$333
c.
$414
d.
$500
e.
$666
13. Gemini Inc.’s optimal cash transfer amount, using the Baumol model, is $60,000. The firm’s fixed cost
per cash transfer of marketable securities to cash is $180, and the total cash needed for transactions
annually is $960,000. On what opportunity cost of holding cash was this analysis based?
a.
19.2%
b.
10.4%
c.
6.3%
d.
12.1%
e.
9.6%
14. Gemini Inc.’s optimal cash transfer amount, using the Baumol model, is $60,000. The firm’s fixed cost
per cash transfer of marketable securities to cash is $180. In addition, the total estimated cash costs
(transfers and carrying cost) for the firm, based on 16 transactions per year, are $5,760. On what
opportunity cost of holding cash was this analysis based?
a.
19.2%
b.
10.4%
c.
6.3%
d.
12.1%
e.
9.6%
15. Suppose Stanley’s Office Supply purchases 50,000 boxes of pens every year. Ordering costs are $100
per order and carrying costs are $0.40 per box. Moreover, management has determined that the EOQ is
5,000 boxes. The vendor now offers a quantity discount of $0.20 per box if the company buys pens in
order sizes of 10,000 boxes. Determine the before-tax benefit or loss of accepting the quantity
discount. (Assume the carrying cost remains at $0.40 per box whether or not the discount is taken.)
a.
$1,000 loss
b.
$1,000 benefit
c.
$500 loss
d.
$500 benefit
e.
$0 (The change would not affect profits.)
16. Each year, Holly’s Best Salad Dressing, Inc. (HBSD) purchases 50,000 gallons of extra virgin olive
oil. Ordering costs are $100 per order, and the carrying cost, as a percentage of inventory value, is 80
percent. The purchase price to HBSD is $0.50 per gallon. Management currently orders the EOQ each
time an order is placed. No safety stock is carried. The supplier is now offering a quantity discount of
$0.03 per gallon if HBSD orders 10,000 gallons at a time. Should HBSD take the discount?
a.
From a cost standpoint, HBSD is indifferent.
b.
No, the cost exceeds the benefit by $500.
c.
No, the cost exceeds the benefit by $1,000.
d.
Yes, the benefit exceeds the cost by $500.
e.
Yes, the benefit exceeds the cost by $1,120.
17. New England Charm, Inc. specializes in selling scented candles. The company has established a policy
of reordering inventory every 30 days. A recently employed MBA has considered New England’s
inventory problem from the EOQ model viewpoint. If the following constitute the relevant data, how
does the current policy compare with the optimal policy?
Ordering cost
= $10 per order
Carrying cost
= 20% of purchase price
Purchase price
= $10 per unit
Total sales for year
= 1,000 units
Safety stock
= 0
a.
Total costs will be the same, since the current policy is optimal.
b.
Total costs under the current policy will be less than total costs under the EOQ by $10.
c.
Total costs under the current policy exceed those under the EOQ by $3.
d.
Total costs under the current policy exceed those under the EOQ by $10.
e.
Cannot be determined due to insufficient information.
18. Refer to Exhibit 28.1. According to the Baumol model, what is the optimal transaction size for
transfers from marketable securities to cash?
a.
$7,071
b.
$38,357
c.
$70,711
d.
$102,956
e.
$87,000
19. Refer to Exhibit 28.1. According to the Baumol model, what should be Duckett’s average cash
balance?
a.
$35,356
b.
$3,536
c.
$22,157
d.
$70,711
e.
$42,918
20. Refer to Exhibit 28.1. What will be the total cost to Duckett of maintaining the optimal average cash
balance, as determined by the Baumol model?
a.
$35,356
b.
$7,071
c.
$18,493
d.
$70,711
e.
$53,190
21. Refer to Exhibit 28.2. What is the economic ordering quantity for chips?
a.
12,088
b.
3,175
c.
6,243
d.
13,675
e.
8,124
22. Refer to Exhibit 28.2. If Cartwright holds a safety stock equal to a 30-day supply of chips, what is its
average inventory level?
a.
12,088
b.
3,175
c.
15,750
d.
13,675
e.
8,124
23. Refer to Exhibit 28.2. Assume that Cartwright holds a safety stock equal to a 30-day supply of chips.
What is the maximum amount of inventory that will have on hand at any time, that is, what will be the
inventory level right after a delivery is made?
a.
9,216
b.
3,175
c.
6,243
d.
13,675
e.
8,124
24. Refer to Exhibit 28.2. How many orders should Cartwright place during the year?
a.
12
b.
25
c.
30
d.
40
e.
60
25. Refer to Exhibit 28.2. If the lead time for placing an order is 5 days, and Cartwright holds a safety
stock equal to a 30-day supply of chips, then at what inventory level should an order be placed?
a.
15,570
b.
3,175
c.
12,250
d.
13,675
e.
8,124
26. Refer to Exhibit 28.2. If Cartwright holds a safety stock equal to a 30-day supply of chips, what is
Cartwright’s minimum cost of ordering and carrying inventory?
a.
$28,500
b.
$15,950
c.
$68,440
d.
$34,220
e.
$47,693
27. Refer to Exhibit 28.3. What is the firm’s EOQ?
a.
26,833
b.
30,040
c.
43,987
d.
13,563
e.
21,456
28. Refer to Exhibit 28.3. What is Palmer’s minimum costs of ordering and holding inventory?
a.
$6,254
b.
$10,733
c.
$11,560
d.
$13,563
e.
$19,825
29. Refer to Exhibit 28.3. Now, suppose the manufacturer offers a discount of 0.5 percent for orders of a
least 40,000 gallons. Should Palmer increase its ordering quantity to take the discount?
a.
Yes; it will save $827 if it takes the discount.
b.
No; it will lose $827 if it takes the discount.
c.
Yes; it will save $14,400 if it takes the discount.
d.
Yes; it will save $13,573 if it takes the discount.
e.
No; it will lose $13,573 if it takes the discount.