Deck 21: The Management of Accounts Receivable and Inventories

Question 1

The primary goal of accounts receivable management should be ____.

A) minimizing lost sales
B) maximizing shareholder wealth
C) increasing market share
D) minimizing receivables investment

Answer 1

B

Question 2

The ____ measures the promptness with which customers repay their credit obligations.

A) bad-debt loss ratio
B) average collection period
C) credit term
D) cash discount

Answer 2

B

Question 3

Traditional discussion of guidelines for examining credit worthiness include "the five Cs of credit." Which of the following is not one of the "five Cs"?

A) Capacity
B) Cooperation
C) Character
D) Conditions

Answer 3

B

Question 4

Relaxing (i.e., lowering) the firm's credit standards is likely to result in ____.

A) lower sales
B) smaller bad-debt losses
C) a shorter average collection period
D) possible higher pre-tax profits

Question 5

Which of the following is(are) not related to the extension of credit to customers?

A) Compensating balances
B) Cash discounts
C) Quantity discounts
D) Compensating balances and quantity discounts

Question 6

The objective of offering seasonal datings to customers is to ____.

A) encourage customers to place their orders prior to the peak selling period
B) speed up the collection of accounts receivable
C) increase the firm's inventory storage costs
D) reduce the number of bad checks received from customers

Question 7

Which of the following is not a cost related to the extension of credit to customers?

A) Bad-debt losses
B) Cash discounts
C) Quantity discounts
D) Collection costs

Question 8

The effect of a change in a firm's credit terms from "net 30" to "2/10, net 30" on its customers' balance sheets is likely to be ____.

A) decreased accounts receivable
B) increased accounts receivable
C) decreased accounts payable
D) increased accounts payable

Question 9

The average collection period measures the number of days ____.

A) between when a typical credit sale is made and when the firm receives the payment
B) it takes a typical check to "clear" through the banking system
C) beyond the end of the credit period before a typical customer payment is received
D) before a typical account becomes delinquent

Question 10

The primary objective of offering a cash discount is to ____.

A) reduce the firm's level of receivables investment
B) reduce the number of bad checks received from customers
C) encourage customers to place their orders prior to the peak selling period
D) avoid just-in-time orders

Question 11

Lengthening the credit period is likely to result in all except which of the following?

A) Higher sales
B) More cash sales
C) Larger investment in receivables
D) Longer average collection period

Question 12

____ are useful in monitoring the status and composition of a firm's accounts receivable.

A) Numerical credit scoring systems
B) Aging of accounts schedules
C) Seasonal datings
D) Aging of accounts schedules and seasonal datings

Question 13

For the firm with a seasonal sales pattern, offering seasonal datings to its customers is likely to result in ____.

A) increased sales
B) higher inventory investment and warehousing costs
C) lower receivables investment cost
D) an offer of a cash discount

Question 14

Character, which is one of the traditional "five Cs" of credit analysis, refers to the ____.

A) ability of the applicant to meet its financial obligations (i.e., liquidity and cash flow)
B) general economic climate and its effect on the applicant's ability to pay
C) financial strength of the applicant (i.e., net worth)
D) willingness of the applicant to meet its financial obligations

Question 15

Possible sources of relevant information about a credit applicant include ____.

A) financial statements submitted by the applicant
B) credit reporting organizations
C) The U.S. Department of Commerce
D) the applicant's financial statements and credit reporting agencies

Question 16

____ refers to the applicant's financial strength, particularly with respect to net worth.

A) Character
B) Capacity
C) Capital
D) Collateral

Question 17

Potential losses can occur in the credit evaluation process when ____.

A) credit is denied to a creditworthy customer
B) the credit decision is delayed too long
C) credit is denied to a customer who is not credit worthy
D) credit is denied to a creditworthy customer and the credit decision is delayed too long

Question 18

The effect of a change in a firm's credit terms from "net 30" to "2/10, net 30" on its own balance sheet is likely to be ____.

A) decreased accounts receivable
B) increased accounts receivable
C) decreased accounts payable
D) increased accounts payable

Question 19

Capacity, which is one of the traditional "five Cs" of credit analysis, refers to the ____.

A) general economic climate and its effect on the applicant's ability to pay
B) willingness of the applicant to meet its financial obligations
C) financial strength of the applicant (i.e., net worth)
D) ability of an applicant to meet its financial obligations

Question 20

The credit policy variables a firm can use to exercise control over its level of receivables investment include ____.

A) credit standards
B) credit terms
C) collection effort
D) credit standards, credit terms, and collection effort

Question 21

The types of inventories that manufacturing firms generally hold include all except which of the following?

A) Raw materials
B) Working stock
C) Finished goods
D) Work-in-process

Question 22

When an order is placed for an item that is manufactured internally within a company, ordering costs consist primarily of ____.

A) storage and handling costs
B) deterioration costs
C) production setup costs
D) carrying costs

Question 23

To minimize the possibility of running out of inventory, most companies add a ____ to their inventory.

A) safety stock
B) lead time stock level
C) few days
D) replenishment factor

Question 24

Mace Auto Parts Company sells to retail auto supply stores on credit terms of "net 60." Annual credit sales are $300 million (spread evenly throughout the year) and its accounts average 28 days overdue. The firm's variable cost ratio is 0.75 (i.e., variable costs are 75% of sales). When converting from annual to daily data or vice versa, assume there are 365 days per year. Determine Mace's average collection period.

A) 88 days
B) 44 days
C) 74 days
D) 60 days

Question 25

Warren Motor Company sells $30 million of its products to wholesalers on terms of "net 30." Currently, the firm's average collection period is 48 days. To speed up the collection of receivables, Warren is considering offering a cash discount of 2% if customers pay their bills within 10 days. The firm expects 50% of its customers to take the discount and its average collection period to decline to 30 days. The firm's required pretax return (i.e., opportunity cost) on receivables investment is 16%. Determine the net effect on Warren's pretax profits of offering a 2% cash discount.

A) $300,000
B) $236,712
C) -$63,288
D) -$236,712

Question 26

The ____ is the inventory level at which an order should be placed for replenishment of an item.

A) nonzero inventory level
B) safety stock
C) reorder point
D) inventory quantity

Question 27

Mace Auto Parts Company sells to retail auto supply stores on credit terms of "net 60." Annual credit sales are $300 million (spread evenly throughout the year) and its accounts average 28 days overdue. The firm's variable cost ratio is 0.75 (i.e., variable costs are 75% of sales). When converting from annual to daily data or vice versa, assume there are 365 days per year. Suppose that Mace's sales are expected to increase by 20% next year and, through more effective collection methods, the firm can reduce its average collection period by 20 days. Determine the firm's average investment in receivables for next year under these conditions.

A) $67,068,493
B) $56,666,667
C) $5,294,118
D) $98,630

Question 28

Mace Auto Parts Company sells to retail auto supply stores on credit terms of "net 60." Annual credit sales are $300 million (spread evenly throughout the year) and its accounts average 28 days overdue. The firm's variable cost ratio is 0.75 (i.e., variable costs are 75% of sales). When converting from annual to daily data or vice versa, assume there are 365 days per year. Determine Mace's average investment in receivables.

A) $821,918
B) $3,409,091
C) $72,328,767
D) $82,192

Question 29

The cost of funds invested in inventories is measured by the ____.

A) cost of insuring the inventory
B) stockout costs
C) required rate of return
D) rate of interest on borrowed funds

Question 30

The reorder point is ____.

A) the lead time multiplied by the daily usage plus safety stock
B) the EOQ plus safety stock
C) the lead time multiplied by the annual usage
D) a product of daily usage and the lead time

Question 31

All except which of the following are components of carrying costs?

A) Insurance
B) Storage costs
C) Handling costs
D) Set-up costs

Question 32

Increasing collection expenditures is likely to result in ____.

A) a shorter average collection period
B) reduced bad-debt losses
C) higher accounts receivable balances
D) a shorter average collection period and reduced bad-debt losses

Question 33

____ are the criteria the firm uses to screen credit applicants to determine which of its customers should be offered credit and how much.

A) Credit terms
B) Credit standards
C) Seasonal datings
D) Credit extension policies

Question 34

Warren Motor Company sells $30 million of its products to wholesalers on terms of "net 30." Currently, the firm's average collection period is 48 days. To speed up the collection of receivables, Warren is considering offering a cash discount of 2% if customers pay their bills within 10 days. The firm expects 50% of its customers to take the discount and its average collection period to decline to 30 days. The firm's required pretax return (i.e., opportunity cost) on receivables investment is 16%. Determine the cost of the cash discounts to Warren.

A) $300,000
B) $60,000
C) $40,000
D) $48,000

Question 35

All except which of the following are assumptions of the basic EOQ model?

A) Annual demand is known with certainty
B) Ordering costs fluctuate
C) Demand is uniform throughout the year
D) Orders are filled instantaneously

Question 36

Bluegrass Distilleries, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them. This policy results in lost sales of $10 million annually. Based on experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6%. The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20. Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20%. When converting from annual to daily or vice versa, assume there are 365 days per year. If Bluegrass Distilleries extends credit to these (previously delinquent) customers, determine the increase in the investment in receivables.

A) $27,397
B) $2,465,753
C) $111,111
D) $125,000

Question 37

In general, the ____ a firm's production cycle, the ____ its work-in-process inventory.

A) longer; larger
B) longer; smaller
C) shorter; larger
D) None of these; length of cycle is not related to amount of work-in-process.

Question 38

Safety stock is needed to absorb ____.

A) changes in accounts receivables
B) cyclical changes
C) random fluctuations in sales
D) annual model changes

Question 39

Warren Motor Company sells $30 million of its products to wholesalers on terms of "net 30." Currently, the firm's average collection period is 48 days. To speed up the collection of receivables, Warren is considering offering a cash discount of 2% if customers pay their bills within 10 days. The firm expects 50% of its customers to take the discount and its average collection period to decline to 30 days. The firm's required pretax return (i.e., opportunity cost) on receivables investment is 16%. Determine Warren's pretax earnings on the funds released from the reduction in receivables. (Assume a 365-day year.)

A) $1,479,452
B) $236,712
C) $266,667
D) $1,082,191

Question 40

Each of the firms listed applied seasonal datings to the terms of credit they offer. This would be expected to generate additional sales for all except which of the firms?

A) A Christmas novelty manufacturer
B) An agricultural implements manufacturer
C) A wholesale frozen food supplier
D) A swimsuit manufacturer

Question 41

Whirlwind Company sells to retail appliance stores on credit terms of net 30. Annual credit sales are $182,500,000 spread evenly throughout the year, and its accounts average 20 days overdue. The firm's variable cost ratio is 0.70. Determine Whirlwind's average investment in receivables. (Assume 365 days per year in all calculations.)

A) $17,500,000
B) $25,000,000
C) $15,000,000
D) Cannot be determined from the information provided

Question 42

Bluegrass Distilleries, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them. This policy results in lost sales of $10 million annually. Based on experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6%. The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20. Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20%. When converting from annual to daily data or vice versa, assume there are 365 days per year. Assuming Bluegrass extends full credit to these (previously delinquent) customers, determine the total increase in credit-related costs.

A) $1,000,000
B) $1,093,151
C) $400,000
D) $600,000

Question 43

Technico manufactures about 800,000 solar calculators per year. The computer chips used in the calculator cost $4.80 each, and the cost of placing an order is $65. If the carrying costs are 16%, what is the EOQ for the chips?

A) 25,495
B) 3,162
C) 8, 229
D) 11,637

Question 44

Cycles de Oro produces 120,000 high-tek bikes a year and orders the brake assembly from IKON for $15.40 each. The order cost is $84, and Cycles estimates its inventory carrying costs are 15%. What is its total ordering cost per year?

A) $7,968
B) $3,412
C) $4,118
D) $6,437

Question 45

RCMP has annual credit sales of $37 million. The credit terms are "net 30," and the current average collection period is 45 days. RCMP is considering changing its terms to "1/10, net 30" in an effort to reduce the average collection period. RCMP believes that 35% of its customers will take the discount, reducing the average collection period to 33 days. Should RCMP offer the discount? Why or why not? Assume the firm's required rate of return on its receivables investment is 14%.

A) No; pretax profits decrease $88,700
B) Yes; pretax profits increase $53,600
C) Yes; pretax profits increase $40,801
D) No; pretax profits decrease $40,801

Question 46

Accounts receivable consists of the credit of the business. It can take the form of which of the following?
I. Trade credit
II. Consumer credit

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 47

What is the optimal length of one inventory cycle for a firm that has an economic order quantity of 750 units, average daily demand of 68 units, and a price of $30 per unit?

A) 25 days
B) 11 days
C) 2.7 days
D) 331 days

Question 48

Tool Mart sells 1,400 electronic water pumps every year. These pumps cost $54.30 each. If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the optimal ordering frequency?

A) 37 days
B) 32 days
C) 40 days
D) 51 days

Question 49

Haulsee Inc. builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each. Ordering costs are $540, and Haulsee's inventory carrying costs average 14% of the inventory value. What is the EOQ for Haulsee?

A) 4,084
B) 1,528
C) 2,890
D) 572

Question 50

If a lawn mower assembly plant orders 25,000 frames per year at a price of $27 each, what is the EOQ if the ordering cost per order is $35 and the annual inventory carrying cost is 12%?

A) 735
B) 255
C) 567
D) 520

Question 51

Tool Mart sells 1,400 electronic water pumps every year. These pumps cost $54.30 each. If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the total annual inventory costs?

A) $1,923
B) $1,281
C) $3,406
D) $3,762

Question 52

Wallace Company sells $73 million of its products to retailers on credit terms of "net 30." Its average collection period is 55 days. To speed up the collection of receivables, the company is considering changing its credit terms to "2/10, net 30." The company expects 40% of its customers to take the cash discount and its average collection period to decline to 35 days. Wallace's required pretax rate of return on receivables investments is 15%. Determine the net effect on Wallace's pretax profits of the change in credit terms. (Assume 365 days per year in any calculations.)

A) -$860,000
B) $600,000
C) $16,000
D) $584,000

Question 53

Bluegrass Distilleries, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them. This policy results in lost sales of $10 million annually. Based on experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6%. The firm's variable cost ratio is 0.80, making its profit contribution ratio 0.20. Bluegrass Distilleries' required pretax return (i.e., opportunity cost) on receivables investments is 20%. When converting from annual to daily data or vice versa, assume there are 365 days per year. Determine the net effect on Bluegrass Distilleries' pretax profits of extending credit to these (previously delinquent) customers

A) $906,849
B) $2,000,000
C) $306,849
D) $1,500,000

Question 54

The United Shoe Company (USC) does not extend credit to any retail shoe store with a "Fair" or "Limited" Dun and Bradstreet credit rating. Because of this policy, the company loses $36,500,000 in sales each year. Based on prior experience with these types of customers, USC estimates that the average collection period would be 120 days and the bad-debt loss ratio would be 10%. The firm's variable cost ratio is 0.75. USC's required pretax return on receivables investments is 18%. Determine the net change in pretax profits of extending credit to these retail shoe stores. (Assume 365 days per year in any calculations.)

A) $9,125,000
B) $3,315,000
C) -$1,095,000
D) $2,160,000

Question 55

Tool Mart sells 1,400 electronic water pumps every year. These pumps cost $54.30 each. If annual inventory carrying costs are 12% and the cost of placing an order is $90, what is the firm's EOQ?

A) 139
B) 122
C) 197
D) 148

Question 56

Willoughby Industries, Inc. is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them. Current annual credit sales are $10 million on credit terms of "net 30." Such a change in policy is expected to reduce sales by 10%, cut the firm's bad-debt losses from 5% to 3%, and reduce its average collection period from 72 days to 45 days. The firm's variable cost ratio is 0.70 (profit contribution ratio is 0.30), and its required pretax return (i.e., opportunity cost) on receivables investments is 25%. Determine the net effect of this credit tightening policy on the pretax profits of Willoughby. When converting from annual to daily data or vice versa, assume that there are 365 days per year.

A) -$863,014
B) $145,753
C) -$70,000
D) $300,000

Question 57

Covers, Inc. (CI) sells its stainless steel products on terms of "2/10, net 40." CI is considering granting credit to retailers with total assets as low as $500,000. Currently the lowest asset limit is $750,000. CI believes sales will increase $7 million from the new credit group but the average collection period for this new group will be 60 days versus the current average collection period of 35 days. If management estimates that 20% of the new customers will take the cash discount but 4% of the new business will be written off as a bad-debt loss, should CI lower its credit standards? Why or why not? Assume CI's variable cost ratio is 0.7 and its required pretax rate of return on receivables investment is 15%.

A) Yes; pretax profits increase $1,619,397
B) Yes; pretax profits increase $1,703,397
C) Yes; pretax profits increase $1,755,178
D) No; Pretax profits will decrease

Question 58

When a company measures its marginal costs and marginal returns, it is developing a(n) ____.

A) target capital structure
B) optimal credit extension policy
C) required rate of return
D) financing decision

Question 59

Haulsee Inc. builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each. Ordering costs are $540, and Haulsee's inventory carrying costs average 14% of the inventory value. What is the optimal ordering frequency?

A) 0.70 days
B) 1.86 days
C) 5.18 days
D) 8.64 days

Question 60

Haulsee Inc. builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each. Ordering costs are $540, and Haulsee's inventory carrying costs average 14% of the inventory value. What is the total inventory costs?

A) $565,445
B) $224,331
C) $211,554
D) $21,155,120

Question 61

The proportion of the total receivables volume a company never collects is the ____.

A) bad-debt loss ratio
B) mismanaged accounts payable
C) uncollectable bills
D) recorded debts

Question 62

Which of the following is not an inventory-related cost?

A) Ordering costs
B) Product advertising costs
C) Carrying costs
D) Stockout costs

Question 63

All except which of the following are reliable sources of the creditworthiness of a customer?

A) Credit- reporting organizations
B) The company's own experience with the customer
C) Banks
D) A general credit application

Question 64

Maximizing shareholder wealth by investing in accounts receivables is considered when ____.
I. marginal costs are exceeded by marginal returns.
II. the cost of the funds invested are exceeded by expected marginal returns.

A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements I and II are correct.
D) Neither statement I nor II is correct.

Question 65

What are seasonal datings as applied to credit terms?

Question 66

How can a company use its credit period to affect sales and inventory?

Question 67

In determining the creditworthiness of a customer from financial statements, the statements can indicate all except which of the following?

A) Financial strength
B) Ability to repay credit obligations
C) Length of time needed to repay on credit
D) Proposed budgetary expenses for the near future

Question 68

All except which of the following are examples of credit-related marginal costs?

A) Advertising costs associated with promoting the company's credit policy
B) Opportunity costs associated with supporting a higher level of receivables
C) Labor costs associated with checking new credit accounts and collecting receivables
D) Bad-debt expenses

Question 69

How does an optimal credit extension policy impact a company's accounts receivables?

Question 70

Seasonal datings are offered to specific retailers. These retailers ____.

A) do not have the capacity to make sales without seasonal dating
B) do not have the ability to finance a buildup of inventory in advance of the peak selling period
C) are known to be credit-risky
D) are considered a distributive subsidiary of the parent company

Question 71

Which of the following is the most widely known credit-reporting organization?

A) Phelps Credit Services
B) Dun & Bradstreet Credit Services
C) Equitable Credit Services
D) Creditreport.com

Question 72

A numerical credit scoring system may rate all except which of the following?

A) D&B credit rating
B) Location of the business
C) Financial characteristics of the applicant
D) Current ratio of the applicant

Question 73

Describe how an aging of accounts is a useful monitoring technique for accounts receivable.

Question 74

Cash discounts are offered for which of the following reasons?
I. To speed up collection of accounts receivable.
II. To reduce a company's level of receivables investment and associated costs.

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 75

____ serves as a buffer between the various phases in the procurement-production-sales cycle of a manufacturing firm.

A) Cash
B) Accounts receivable
C) Notes payable
D) Inventories

Question 76

All except which of the following are possible solutions to a large bad-debt loss ratio?

A) Loosening credit
B) Offering cash discounts for prompt payment
C) Seasonal datings
D) Determining creditworthiness of customers

Question 77

The likelihood that a customer will fail to repay credit extended to it is referred to as ____.

A) default risk
B) maturity risk
C) bad-debt loss ratio
D) opportunity cost