Deck 23: Other Topics in Working Capital Management

Question 1

Which of the following is true of the Baumol model? Note that the optimal cash transfer amount is C*?

A) If the fixed costs of selling securities or obtaining a loan (cost per transaction) increase by 20%, then C* will increase by 20%
B) If the total amount of cash needed during the year increases by 20%, then C* will increase by 20%.
C) If the average cash balance increases by 20%, then the total holding costs will increase by 20%.
D) If the average cash balance increases by 20% the total transactions costs will increase by 20%.
E) None of the above is true.

Answer 1

C

Question 2

Fullerton Wine Company is a retailer which sells vintage wines. The company has established a policy of reordering inventory every 30 days. A recently employed MBA has considered Fullerton'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.

Answer 2

C

Question 3

Crystal Clear Company purchases 50,000 gallons of distilled water each year. Ordering costs are $100 per order, and the carrying cost, as a percentage of inventory value, is 80 percent. The purchase price to CCC 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 CCC orders 10,000 gallons at a time. Should CCC take the discount?

A) From a cost standpoint, CCC 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.

Answer 3

E

Question 4

During times of inflation, which of these inventory accounting methods is best for cash flow?

A) FIFO, because the cheapest goods are recorded as being sold first, resulting in lower cost of goods sold and higher reported net income.
B) 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.
C) Specific identification, because it correctly identifies the actual item sold and so the actual cost is recorded on the income statement.
D) Weighted average, because it smoothes the reported cost of goods sold over time.
E) It doesn't matter which you use since cash flow is unaffected by the choice of inventory identification method.

Question 5

Williams Company'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. 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%

Question 6

The Norris Company is trying to determine its optimal average cash balance.
The firm has determined that it will need $5,000,000 net new cash during the coming year. The fixed transaction cost of converting securities to cash is $50, and the firm earns 10 percent on its marketable securities investments.
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

Question 7

Which of the following would cause average inventory holdings to decrease, other things held constant?

A) Fixed order costs double.
B) The purchase price of inventory items decreases by 50 percent.
C) The carrying price of an item decreases (as a percent of purchase price).
D) The sales forecast is revised downward by 10 percent.
E) None of the above (all would cause average inventory to increase).

Question 8

If a company increases its safety stock, then its average inventory will go up.

Question 9

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.

Question 10

Suppose the Campus Bookstore purchases 50,000 boxes of writing tablets 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 tablets 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.)

Question 11

Which of the following is true of the EOQ model? Note that the optimal order quantity, Q, will be called EOQ.

A) If the fixed per order cost increases by 20%, then EOQ will increase by 20%
B) If the annual sales, in units, increases by 20%, then EOQ will increase by 20%.
C) If the average inventory increases by 20%, then the total carrying costs will increase by 20%.
D) If the average inventory increases by 20% the total order costs will increase by 20%.
E) None of the above is true.

Question 12

A just-in-time system is designed to stretch accounts payable as long as possible.

Question 13

If a company increases its safety stock, then its EOQ will go up.

Question 14

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.

Question 15

Thoroughbred Industries 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

Question 16

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.

Question 17

Which of the following has to do with inventory management?

A) Economic Order Quintile
B) In the Nick of Time
C) Few In, Lots Out
D) Red-line
E) None of the above

Question 18

The Norris Company is trying to determine its optimal average cash balance.
The firm has determined that it will need $5,000,000 net new cash during the coming year. The fixed transaction cost of converting securities to cash is $50, and the firm earns 10 percent on its marketable securities investments.
According to the Baumol model, what should be Norris' average cash balance?

A) $35,356
B) $ 3,536
C) $22,157
D) $70,711
E) $42,918

Question 19

Once each year, B. Smith Inc. receives a $2 million payment. Of this amount, $700,000 is needed for cash payments made during the next year. Each time Smith deposits money in its account, a charge of $2.00 is assessed to cover clerical costs. If Smith can hold marketable securities which 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

Question 20

All of the following have to do with inventory management except

A) EOQ
B) JIT
C) FIFO
D) LIFO
E) DSO

Question 21

Aberwald Corporation expects to order 126,000 memory chips for inventory during the coming year, and it will use this inventory at a constant rate. Fixed ordering costs are $200 per order; the purchase price per chip is $25; and the firm's inventory carrying costs is equal to 20 percent of the purchase price. (Assume a 360-day year.)
What is the economic ordering quantity for chips?

A) 12,088
B) 3,175
C) 6,243
D) 13,675
E) 8,124

Question 22

Assume that Fashion Clothiers Inc. uses 1,440,000 yards of material each year. Further, assume that Fashion can order the material at a cost of $2 per yard, plus fixed ordering costs of $100 per order. The firm's carrying cost is 20 percent of the inventory value, at cost.
What is the firm's EOQ?

A) 26,833
B) 30,040
C) 43,987
D) 13,563
E) 21,456

Question 23

The Norris Company is trying to determine its optimal average cash balance.
The firm has determined that it will need $5,000,000 net new cash during the coming year. The fixed transaction cost of converting securities to cash is $50, and the firm earns 10 percent on its marketable securities investments.
What will be the total cost to Norris 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

Question 24

Aberwald Corporation expects to order 126,000 memory chips for inventory during the coming year, and it will use this inventory at a constant rate. Fixed ordering costs are $200 per order; the purchase price per chip is $25; and the firm's inventory carrying costs is equal to 20 percent of the purchase price. (Assume a 360-day year.)
Assume that Aberwald holds a safety stock equal to a 30-day supply of chips. What is the maximum amount of inventory that Aberwald 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

Question 25

Assume that Fashion Clothiers Inc. uses 1,440,000 yards of material each year. Further, assume that Fashion can order the material at a cost of $2 per yard, plus fixed ordering costs of $100 per order. The firm's carrying cost is 20 percent of the inventory value, at cost.
What is Fashion Clothiers' minimum costs of ordering and holding inventory?

A) $ 6,254
B) $10,733
C) $11,560
D) $13,563
E) $19,825

Question 26

If Aberwald holds a safety stock equal to a 30-day supply of chips, what is Aberwald's minimum cost of ordering and carrying inventory?

A) $28,500
B) $15,950
C) $68,440
D) $34,220
E) $47,693

Question 27

How many orders should Aberwald place during the year?

A) 12
B) 25
C) 30
D) 40
E) 60

Question 28

Assume that Fashion Clothiers Inc. uses 1,440,000 yards of material each year. Further, assume that Fashion can order the material at a cost of $2 per yard, plus fixed ordering costs of $100 per order. The firm's carrying cost is 20 percent of the inventory value, at cost.
Now, suppose the manufacturer offers a discount of 0.5 percent for orders of a least 40,000 yards. Should Fashion Clothiers 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.

Question 29

Aberwald Corporation expects to order 126,000 memory chips for inventory during the coming year, and it will use this inventory at a constant rate. Fixed ordering costs are $200 per order; the purchase price per chip is $25; and the firm's inventory carrying costs is equal to 20 percent of the purchase price. (Assume a 360-day year.)
If Aberwald 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

Question 30

If the lead time for placing an order is 5 days, and Aberwald 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