Chapter 20 Credit and Inventory Management Multiple Choice Questions Blackwell Brothers sells men's suits The store offers a percent discount if payment is received within 10 days Otherwise, payment is due within 30 days This credit offering is referred to as the: A terms of sale B credit analysis C collection policy D payables policy E collection float Refer to section 20.1 AACSB: Analytic Blooms: Remember Difficulty: Easy Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies Section: 20.1 Topic: Terms of sale Jillian was recently hired by a major retail store Her job is to determine the probability that individual customers will fail to pay for their charge sales Jillian's job best relates to which one of the following? A terms of sale B credit analysis C collection policy D payables policy E customer service Refer to section 20.1 Town Hardware sells goods on credit with payment due 30 days after purchase If payment is not received by the 30th day, the store mails a friendly reminder to the customer If payment is not received by the 45th day, the store calls the customer and requests payment and also stops offering credit to that customer These procedures are referred to as the store's: A customer service policy B credit policy C collection policy D payables policy E disbursements policy Refer to section 20.1 Phil's Print Shop grants its customers the right to pay for their print jobs within 30 days of the date of service This 30-day period is referred to as the: A payables period B cash cycle C transactions period D credit period E disbursement period Refer to section 20.2 AACSB: Analytic Blooms: Remember Difficulty: Easy Learning Objective: 20-01 How firms manage their receivables and the basic components of a firm's credit policies Section: 20.2 Topic: Credit period Scott purchased a shovel, a rake, and a wheelbarrow from The Local Hardware Store yesterday Today, the store issued a bill for these items and mailed it to Scott What is the name given to this bill? A ledger statement B warran ty C indentu re D recei pt E invoic e Refer to section 20.2 Geoff Industries offers its credit customers a percent discount if they pay within 10 days This discount is referred to as a: A cash discount B purchase discount C collection discount D market discount E receivables discount Refer to section 20.2 The basic factors to be evaluated in the credit evaluation process, the five Cs of credit, are: A conditions, control, cessation, capital, and capacity B conditions, character, capital, control, and capacity C capital, collateral, control, character, and capacity D character, capacity, control, cessation, and collateral E character, capacity, capital, collateral, and conditions Refer to section 20.5 Which one of the following is a system for managing demanddependent inventories that minimizes the inventory levels of a firm? A just-in-time inventory B turnover planning C net working capital planning D inventory scoring E inventory ranking Refer to section 20.8 What is the primary purpose of credit analysis? A determine the optimal credit period B establish the effectiveness of granting a cash discount C determine the optimal discount period, if any D access the frequency and amount of sales by customer E evaluate whether or not a customer will pay Refer to section 20.1 10 The period of time that extends from the day a credit sale is made until the day the bank credits a firm's account with the payment for that sale is known as the _ period A floa t B cash collection C sale s D accounts receivable E discou nt Refer to section 20.1 11 Which one of the following factors tends to favor longer credit periods? A high consumer demand B lower priced merchandise C increased credit risk D merchandise with low collateral value E increased competition Refer to section 20.2 12 Which one of the following credit instruments is commonly used in international commerce? A open account B sight draft C time draft D banker's acceptance E promissory note Refer to section 20.2 13 When evaluating the creditworthiness of a customer, the term character refers to the: A nature of the cash flows of the customer's business B customer's financial resources C types of assets the customer wants to pledge as collateral D customer's willingness to pay bills in a timely fashion E nature of the customer's line of work Refer to section 20.5 14 The EOQ model is designed to determine how much: A total inventory a firm needs in any one year B total inventory costs will be for any one given year C inventory should be purchased at a time D inventory will be sold per day E a firm loses in sales per day when an inventory item is depleted Refer to section 20.8 15 On average, your firm sells $38,700 of items on credit each day The firm's average operating cycle is 49 days and it acquires and sells inventory, on average, every 17 days What is the average accounts receivable balance? Accounts receivable balance = $38,700 × (49 - 17) = $1,238,400 16 The Winter Store just purchased $48,300 of goods from its supplier with credit terms of 2/10, net 25 What is the discounted price? Discounted price = $48,300 × (1 - 0.02) = $47,334 17 Preston Milled Products currently sells a product with a variable cost per unit of $21 and a unit selling price of $40 At the present time, the firm only sells on a cash basis with monthly sales of 2,800 units The monthly interest rate is 0.5 percent What is the switch breakeven point if the firm switched to a net 30 credit policy? Assume the selling price per unit and the variable costs per unit remain constant Break-even point = Q′ - 2,800 = ($40 × 2,800)/{[($40 - $21)/0.005] $21} = 30 units Q′ = 2,800 + 30 = 2,830 units 18 You are trying to attract new customers that you feel could become repeat customers The average selling price of your products is $69 each with a $41 per unit variable cost The monthly interest rate is 1.5 percent Your experience tells you that percent of these customers will never pay their bill What is the value of a new customer who does not default on his or her bill? PV = ($69 - $41)/0.015 = $1,867 19 You are trying to attract new customers that you feel could become repeat customers The average price of your product is $619 per unit with a $435 variable cost per unit The monthly interest rate is 1.8 percent Your experience tells you that percent of these customers will never pay their bill Should you offer credit terms of net 30 to attract these potential customers? Why or why not? NPV = -$435 + {[1 - 0.09] × [($619 - $435)/0.018]} = $8,867 20 A firm offers terms of 2/9, net 41 What effective annual interest rate does the firm earn when a customer does not take the discount? EAR = [1 + (0.02/0.98)]365/(41 - 9) - = 25.92 percent 21 Music City, Inc has an average collection period of 62 days Its average daily investment in receivables is $50,000 What are the annual credit sales? Annual credit sales = $50,000 (365/62) = $294,355 22 The Turn It Up Corporation sells on credit terms of net 30 Its accounts are, on average, days past due Annual credit sales are $7 million What is the company's balance sheet amount in accounts receivable? A/R = $7,000,000 [(30 + 6)/365] = $690,411 23 Roger's Store begins each week with 150 phasers in stock This stock is depleted each week and reordered The carrying cost per phaser is $48 per year and the fixed order cost is $70 What is the optimal number of orders that should be placed each year? EOQ = [(2 × 52 × 150 × $70)/$48]1/2 = 150.83 Number of orders per year = 52(150)/150.83 = 51.71 24 The Cycle Shoppe has decided to offer credit to its customers during the spring selling season Sales are expected to be 330 bicycles The average cost to the shop of a bicycle is $300 The owner knows that only 93 percent of the customers will be able to make their payments To identify the remaining percent, she is considering subscribing to a credit agency The initial charge for this service is $540, with an additional charge of $6 per individual report What is the amount of the net savings from subscribing to the credit agency? Net savings = (330 × $300 × 0.07) - $540 - (330 × $6) = $4,410 Essay Questions 25 Which you feel is the more appropriate upper limit for the credit period that a seller offers to a buyer: the buyer's operating cycle or the buyer's inventory period? The operating cycle is the sum of the inventory and accounts receivable periods The inventory period is probably the better target as an upper limit for the seller's credit period since it is questionable whether or not the seller should be financing the buyer's receivables The credit period should definitely not exceed the buyer's operating period as the seller would then be financing all of the buyer's inventory and accounts receivables, plus other aspects of the buyer's operations Feedback: Refer to section 20.2