CHAPTER 20
CREDIT AND INVENTORY
MANAGEMENT
Answers to Concepts Review and Critical Thinking Questions
1. a. A sight draft is a commercial draft that is payable immediately.
b. A time draft is a commercial draft that does not require immediate payment.
3. Credit costs: cost of debt, probability of default, and the cash discount
4. 1. Character: determines if a customer is willing to pay his or her debts.
2. Capacity: determines if a customer is able to pay debts out of operating cash flow.
5. 1. Perishability and collateral value
2. Consumer demand
3. Cost, profitability, and standardization
If the credit period exceeds a customer’s operating cycle, then the firm is financing the receivables
6. a. B: A is likely to sell for cash only, unless the product really works. If it does, then they might
b. A: Landlords have significantly greater collateral, and that collateral is not mobile.
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7. The three main categories of inventory are: raw material (initial inputs to the firm’s production
process), work-in-progress (partially completed products), and finished goods (products ready for
8. JIT systems reduce inventory amounts. Assuming no adverse effects on sales, inventory turnover
9. Carrying costs should be equal to order costs. Since the carrying costs are low relative to the order
10. Since the price of components can decline quickly, Dell does not have inventory which is purchased
and then declines quickly in value before it is sold. If this happens, the inventory may be sold at a
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
Basic
1. a. There are 30 days until account is overdue. If you take the full period, you must remit:
b. There is a 1 percent discount offered, with a 10-day discount period. If you take the discount,
you will only have to remit:
c. The implicit interest is the difference between the two remittance amounts, or:
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The number of days’ credit offered is:
2. The receivables turnover is:
Receivables turnover = 365 / Average collection period
And the average receivables are:
Average receivables = Sales / Receivables turnover
3. a. The average collection period is the percentage of accounts taking the discount times the
discount period, plus the percentage of accounts not taking the discount times the days until full
payment is required, so:
b. And the average daily balance is:
4. The daily sales are:
Since the average collection period is 34 days, the average accounts receivable is:
5. The interest rate for the term of the discount is:
And the interest is for:
CHAPTER 27 – 4
So, using the EAR equation, the effective annual interest rate is:
EAR = (1 + Periodic rate)m – 1
a. The periodic interest rate is:
And the EAR is:
b. The EAR is:
c. The EAR is:
6. The receivables turnover is:
Receivables turnover = 365 / Average collection period
And the annual credit sales are:
Annual credit sales = Receivables turnover × Average daily receivables
7. The total sales of the firm are equal to the total credit sales since all sales are on credit, so:
The average collection period is the percentage of accounts taking the discount times the discount
period, plus the percentage of accounts not taking the discount times the days until full payment is
required, so:
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The receivables turnover is 365 divided by the average collection period, so:
And the average receivables are the credit sales divided by the receivables turnover so:
If the firm increases the cash discount, more people will pay sooner, thus lowering the average
8. The average collection period is the net credit terms plus the days overdue, so:
The receivables turnover is 365 divided by the average collection period, so:
And the average receivables are the credit sales divided by the receivables turnover so:
9. a. The cash outlay for the credit decision is the variable cost of the engine. If this is a one-time
order, the cash inflow is the present value of the sales price of the engine times one minus the
default probability. So, the NPV per unit is:
The company should fill the order.
b. To find the break-even probability of default, , we simply use the NPV equation from part a,
set it equal to zero, and solve for . Doing so, we get:
We would not accept the order if the default probability was higher than 5.58 percent.
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c. If the customer will become a repeat customer, the cash inflow changes. The cash inflow is now
one minus the default probability, times the sales price minus the variable cost. We need to use
The company should fill the order. The break-even default probability under these assumptions
is:
We would not accept the order if the default probability was higher than 76.96 percent. This
d. It is assumed that if a person has paid his or her bills in the past, they will pay their bills in the
10. The cost of switching is the lost sales from the existing policy plus the incremental variable costs
under the new policy, so:
The benefit of switching is the new sales price minus the variable costs per unit, times the
incremental units sold, so:
The benefit of switching is a perpetuity, so the NPV of the decision to switch is:
The firm will have to bear the cost of sales for one month before they receive any revenue from
11. The carrying costs are the average inventory times the cost of carrying an individual unit, so:
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The order costs are the number of orders times the cost of an order, so:
The economic order quantity is:
EOQ = [(2T × F) / CC]1/2
12. The carrying costs are the average inventory times the cost of carrying an individual unit, so:
The order costs are the number of orders times the cost of an order, so:
The economic order quantity is:
EOQ = [(2T × F) / CC]1/2
The number of orders per year will be the total units sold per year divided by the EOQ, so:
The firm’s policy is not optimal, since the carrying costs and the order costs are not equal. The
company should decrease the order size and increase the number of orders.
Intermediate
13. The total carrying costs are:
where CC is the carrying cost per unit. The restocking costs are:
Setting these equations equal to each other and solving for Q, we find:
CC (Q / 2) = F (T / Q)
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14. The cash flow from either policy is:
Cash flow = (P – v)Q
So, the cash flows from the old policy are:
And the cash flow from the new policy would be:
So, the incremental cash flow would be:
The incremental cash flow is a perpetuity. The cost of initiating the new policy is:
Cost of new policy = –[PQ + v(Q – Q)]
So, the NPV of the decision to change credit policies is: