Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
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SOLUTIONS TO PROBLEMS
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1.
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Credit Policy A B C D
────────── ────────── ────────── ────────
a. Incremental
sales $2,800,000 $1,800,000 $1,200,000 $600,000
b. Incremental
profitability1 280,000 180,000 120,000 60,000
c. New receivable
turnover2 8 6 4 2.5
d. Additional
receivables3 $350,000 $300,000 $300,000 $240,000
e. Additional
investment4 315,000 270,000 270,000 216,000
f. Opportunity cost5 94,500 81,000 81,000 64,800
g. (b) > (f)? yes yes yes no
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1(10% contribution margin) x (incremental sales)
2(360 days/new average collection period)
3(incremental sales/new receivable turnover)
4(0.9) x (additional receivables)
5(.30) x (additional receivables)
The company should adopt credit policy C because incremental
profitability exceeds the increased carrying costs for policies A,
B, and C, but not for policy D.
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 139
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
2.
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Credit Policy A B C D
—————————— —————————— —————————— ————————
a. Incremental
sales $2,800,000 $1,800,000 $1,200,000 $600,000
b. Percent default 3% 6% 10% 15%
c. Incremental bad-
debt losses
(a) x (b) $84,000 $108,000 $120,000 $90,000
d. Opportunity cost
(from Ans. #1) 94,500 81,000 81,000 64,800
—————————— —————————— —————————— ————————
e. Total costs
(c) + (d) 178,500 189,000 201,000 154,800
f. Incremental
profitability
(from Ans. #1) 280,000 180,000 120,000 60,000
g. (f) > (e)? yes no no no
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Adopt credit policy A. It is the only one where incremental
profitability exceeds opportunity costs plus bad-debt losses.
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 140
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
3.
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Credit Policy A B C D
—————————— —————————— —————————— ————————
a. Incremental
sales $2,800,000 $1,800,000 $1,200,000 $600,000
b. Percent default 1.5% 3% 5% 7.5%
c. Incremental bad-
debt losses
(a) x (b) $42,000 $ 54,000 $ 60,000 $45,000
d. Opportunity cost
(from Ans. #1) 94,500 81,000 81,000 64,800
—————————— —————————— —————————— ————————
e. Total costs
(c) + (d) 136,500 135,000 141,000 109,800
f. Incremental
profitability
(from Ans. #1) 280,000 180,000 120,000 60,000
g. (f) > (e)? yes yes no no
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Credit policy B now would be best. Any more liberal credit policy
beyond this point would only result in more incremental costs than
benefits.
4. Current investment in accounts receivable =
(60/360) x ([.8] x [$10,000,000]) = $1,333,333
New policy investment in accounts receivable =
(40/360) x ([.8] x [$10,000,000]) = $ 888,889
Investment reduction = $1,333,333 - $888,889 = $444,444
Profit from change = (.12) x ($444,444) = $53,333
Cost of change = (.02) x ($8,000,000) x (.60) = $96,000
Change should not be made. The incremental cost ($96,000) is
higher than the incremental profit ($53,000).
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 141
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
5.
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Present New Program Assuming New Program Assuming
Program 20% Opportunity Cost 10% Opportunity Cost
——————— ———————————————————— ————————————————————
a. Annual sales $12 million $12 million $12 million
b. Receivable
turnover (RT)
(360 days/RTD) 4.8 6 6
c. Receivable
level
(b)/(a) $2,500,000 $2,000,000 $2,000,000
d. Reduction
from present
level
$2.5M - (c) N/A 500,000 500,000
e. Return on
reduction
(at 20% and 10%
opportunity costs) N/A 100,000 50,000
f. Bad-debt %-age 4% 3% 3%
g. Annual bad-debt
losses
(a) x (f) $480,000 $360,000 $360,000
h. Reduction in
bad-debt
losses
$480,000 - (g) N/A 120,000 120,000
i. (e) + (h) N/A 220,000 170,000
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As the sum of the return on the reduction in receivables with a 20
percent opportunity cost plus the reduction in bad-debt losses
exceeds the increased collection expense of $180,000, the
intensified collection program should be undertaken. If the
opportunity cost is 10 percent, however, the program is not
worthwhile as shown in the last column.
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 142
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
6. Positive factors:
a) The firm has maintained a reasonably good cash position over
the period.
b) The firm has reduced by 50% its outstanding long-term debt.
c) The firm has been increasing its net worth by $1 million
annually.
d) The firm has taken cash discounts when offered.
Negative factors:
a) The firm has only a "fair" Dun & Bradstreet rating.
b) The firm has been a slow payer to trade creditors not offering
a discount.
c) The liquidity of the firm has been reduced substantially over
the past three years as the acid-test ratio went from 1.28 to
1.05 to 0.92. Short-term debt and trade credit from suppliers
have increased faster than total liabilities and net worth
while inventory and receivable turnovers have slowed.
d) Cost of goods sold has increased from 75.3% to 76.6% to 80.2%.
7. a) C(Q/2) + O(S/Q) = TC
(1X): $1(5,000/2) + $100(5,000/5,000) = $2,600
(2X): $1(2,500/2) + $100(5,000/2,500) = $1,450
(5X): $1(1,000/2) + $100(5,000/1,000) = $1,000
(10X): $1(500/2) + $100(5,000/500) = $1,250
(20X): $1(250/2) + $100(5,000/250) = $2,125
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 143
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
b) ┌──── ┌─────────────────
│ 2OS │ (2)($100)(5,000) ┌──────────
Q* = │ ─── = │ ──────────────── = \│ 1 million = 1,000
\│ C \│ $1
c) It is assumed that sales are made at a steady rate, which may
not be correct for textbooks. The nature of academics
suggests that sales would occur at the beginning of each term.
8. a) Total number of dints required = 150,000 x 12 = 1,800,000
┌─────────────────────
│ (2)($200)(1,800,000) ┌───────────
Q* = │ ─────────────────── = \│ 90,000,000 = 9,487 units
\│ $8
b) TC = C(Q/2) + O(S/Q)
= $8(9,487/2) + $200(1,800,000/9,487)
= $37,948 + $37,947 = $75,895
c) 1,800,000/9,487 = (approx.) 190 times a year, or every 2 days
9. a) TC = C(Q/2) + O(S/Q)
= ($.04)(Q/2) + ($200)(5,000/Q)
Q HC OC TC
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1,000 $ 20 $1,000 $1,020
2,000 40 500 540
3,000 60 333 393
4,000 80 250 330
5,000 100 200 300
6,000 120 167 287
7,000* 140 143 283
8,000 160 125 285
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Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 144
Chapter 10: Accounts Receivable and Inventory Management © Pearson Education Limited 2005
b)
Cost
TC
HC
OC
Quanity
c) Approximately 7,000 units, or 7,071 to be exact
10.
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Incremental
Level of Safety Cost of Carrying Incremental Stockout
Stock (In Gallons) Safety Stock Cost Cost Savings
────────────────── ──────────────── ─────────── ────────────
5,000 $ 3,250 -- --
7,500 4,875 $1,625 $12,000
10,000 6,500 1,625 7,000
12,500 8,125 1,625 4,000
15,000* 9,750 1,625 2,000
17,500 11,375 1,625 1,000
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The level of safety stock should be increased to 15,000 gallons
from 5,000 gallons. Beyond that point incremental costs are larger
than incremental benefits.
Van Horne and Wachowicz: Fundamentals of Financial Management, 12e 145
