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Chapter 07: Current Asset Management
7-11
accounts receivable between various time frames.
12. Economic ordering quantity (LO5) Midwest Tires has expected sales of 12,000 tires this
year, an ordering cost of $6 per order, and carrying costs of $1.60 per tire.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
7-12. Solution:
Midwest Tires
a.
2SO 2 12,000 $6
EOQ C $1.60
$144,000 90,000 300 tires
$1.60
==
= = =
b. 12,000 tires/300 tires = 40 orders
c. EOQ/2 = 300/2 = 150 tires (average inventory)
13. Economic ordering quantity (LO5) Fisk Corporation is trying to improve its inventory
control system and has installed an online computer at its retail stores. Fisk anticipates
sales of 75,000 units per year, an ordering cost of $8 per order, and carrying costs of $1.20
per unit.
a. What is the economic ordering quantity?
b. How many orders will be placed during the year?
c. What will the average inventory be?
Chapter 07: Current Asset Management
7-12
d. What is the total cost of ordering and carrying inventory?
7-13. Solution:
Fisk Corp.
a.
2SO 2 75,000 $8
EOQ 1,000 units
C $1.20
= = =
14. Economic ordering quantity (LO5) (See Problem 13 for basic data.) In the second year,
Fisk Corporation finds that it can reduce ordering 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:
Fisk Corp. (Continued)
a.
2SO 2 75,000 $2
EOQ C $1.20
$300,000 250,000 500 units
$1.20
==
= = =
75,000 units/500 units = 150 orders
EOQ/2 = 500/2 = 250 units (average inventory)
150 orders × $2 ordering cost = $300
Chapter 07: Current Asset Management
7-13
b. The number of units ordered declines 50%, while the number
of orders doubles. The average inventory and total costs both
15. Economic ordering quantity with safety stock (LO5) Diagnostic 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 quantity?
b. What is the average inventory? What is the total carrying cost?
c. Assume an additional 80 units of inventory will be required as safety stock. What will
the new average inventory be? What will the new total carrying cost be?
7-15. Solution:
Diagnostic Supplies
a.
2SO 2 135,000 $4
EOQ C $3
==
$1,080,000 $360,000 600 units
$3
= = =
b. EOQ/2 = 600/2 = 300 units (average inventory)
300 units × $3 carrying cost/unit = $900 total carrying
cost
Chapter 07: Current Asset Management
7-14
c.
EOQ
Average inventory Safety Stock
2
600 80 300 80 380
2
=+
= + = + =
380 inventory × $3 carrying cost per year
= $1,140 total carrying cost
16. Level versus seasonal production (LO5) Wisconsin Snowmobile Corp. is considering a
switch to level production. Cost efficiencies would occur under level production, and
aftertax costs would decline by $30,000, but inventory would increase by $250,000.
Wisconsin Snowmobile have to finance 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 fall before level production would be feasible?
7-16. Solution:
Wisconsin Snowmobile Corporation
a. Inventory increases by $250,000
× interest expense 13.5%
feasible.
Chapter 07: Current Asset Management
7-15
$30,000 Savings 12%
$250,000 increased inventory =
However, the decision 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; this decision can’t
be made on a dip in short-term interest rates below 12%.
17. Credit policy decision (LO4) 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, 10 percent will
prove to be uncollectible. Additional collection costs will be 3 percent of sales, and production
and selling costs will be 79 percent of sales. The firm is in the 40 percent 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. If the receivable turnover ratio is 6 to 1, and no other asset buildup is needed to serve
the new customers, what will Johnson’s incremental return on new average
investment be?
7-17. Solution:
Johnson Electronics
a. Additional sales ................................................... $100,000
Accounts uncollectible (10% of new sales) ......... – 10,000
Annual incremental revenue ................................ $ 90,000
Chapter 07: Current Asset Management
7-16
b.
Incremental income
Incremental return on sales Incremental sales
$4,800 / $100,000 4.8%
=
==
c. Receivable turnover = Sales/Receivable turnover = 6x
Receivables = Sales/Receivable turnover
18. Credit policy decision-receivables and inventory ( LO4 & 5) Henderson Office Supply
is considering a more liberal 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 times. Assume
income taxes of 30 percent and an increase in sales of $60,000. No other asset buildup will
be required to service the new accounts.
a. What is the level of accounts receivable to support this sales expansion?
b. What would be Henderson’s incremental aftertax return on investment?
c. Should Henderson liberalize credit if a 15 percent aftertax return on investment is
required?
Assume that Henderson also needs to increase its level of 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
to support a $60,000 increase in sales?
e. Given the income determined in part b and the investment determined in part d,
should Henderson extend more liberal credit terms?
7-18. Solution:
Chapter 07: Current Asset Management
7-17
Henderson Office Supply
a.
$60,000
Investment in accounts receivable $12,000
5
==
b. Added sales ......................................................... $ 60,000
Accounts uncollectible (8% of new sales) ........... – 4,800
Chapter 07: Current Asset Management
19. Credit policy decision with changing variables (LO4) Comiskey Fence Co. is evaluating
the extension of credit to a new group of customers. Although these customers will provide
$180,000 in additional credit sales, 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 firm is in a 34 percent tax bracket and has a receivables
turnover of five times. No other asset buildup will be required to service the new
customers. The firm 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 are uncollectible (as in part a)?
7-19. Solution:
Comiskey Fence Co.
a. Added sales ........................................................... $180,000
Accounts uncollectible (12% of new sales) ........... 21,600
Annual incremental revenue .................................. 158,400
Chapter 07: Current Asset Management
$180,000
Receivable turnover 5.0x
5.0
$11,022
Return on incremental investment 30.62%
$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
Added sales ......................................................... $180,000
Accounts uncollectible (15% of new sales) ......... 27,000
Annual incremental revenue ................................ $153,000
new receivables
Chapter 07: Current Asset Management
7-20
c. If receivable turnover drops to 1.5x, the investment in
accounts receivable would equal $180,000/1.5 = $120,000
20. Continuation of Problem 19 (LO4) Reconsider problem 19C. Assume the average
collection period is 120 days. All 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 × average daily
period sales
$180,000
120 days 120 $500 $60,000
360 days
= =
or
Accounts receivable = sales/accounts receivable turnover
360 days
Accounts receivable turnover 3x
120 days
==
$180,000 / 3 $60,000=
