Test Prep Test Prep Certifications BUSINESS-ENVIRONMENT-AND-CONCEPTS Questions & Answers

• Question 31:

  The level of safety stock in inventory management depends on all of the following, except the:

  A. Level of uncertainty of the sales forecast.

  B. Level of customer dissatisfaction for back orders.

  C. Level of uncertainty in lead-time for stock shipments.

  D. Cost to reorder stock.

  Correct Answer: D

  Choice "d" is correct. Reorder costs do not impact the level of safety stock. Choices "a", "b", and "c" are incorrect. Safety stock levels are affected by:

  1.

  Uncertain sales forecasts - greater uncertainty means a higher level of safety stock should be carried.

  2.

  Dissatisfaction of customers - if customers are dissatisfied with back orders (which occur when there are stock outs), then more safety stock should be carried to prevent stock outs.

  3.

  Uncertain lead times - greater uncertainty means a higher level of safety stock is needed.

• Question 32:

  The amount of inventory that a company would tend to hold in safety stock would increase as the:

  A. Cost of carrying inventory decreases.

  B. Variability of sales decreases.

  C. Costs of running out of stock decreases.

  D. Length of time that goods are in transit decreases.

  Correct Answer: A

  Choice "a" is correct. As the cost of carrying inventory decreases, safety stock would tend to increase to

  reduce the risk of stock outs. Choice "b" is incorrect. As sales become more predictable (sales variability

  decreases), less (not more) safety stock would be needed because the risk of stock outs would have

  decreased.

  Choice "c" is incorrect. If the cost of stock outs decrease, safety stock would decrease.

  Choice "d" is incorrect. If lead-time decreases, safety stock would decrease.

• Question 33:

  The sales manager at Ryan Company feels confident that if the credit policy at Ryan's was changed, sales would increase and, consequently, the company would utilize excess capacity. The two credit proposals being considered are as follows:

  

  Currently, payment terms are net 30. The proposal payment terms for Proposal A and Proposal B are net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit policy would include all of the following factors, except the:

  A. Cost of funds for Ryan.

  B. Current bad debt experience.

  C. Impact on the current customer base of extending terms to only certain customers.

  D. Bank loan covenants on days sales outstanding.

  Correct Answer: B

  Choice "b" is correct. Because the bad debt percentage is the same under either of the two proposals, there is no differential cost associated with bad debt. Because it is not a differential cost, it is not considered in comparing the two alternatives. Choice "a" is incorrect. Because Proposal A and B have different net collection dates, Proposal B will cause a greater amount of accounts receivable with a corresponding increase in working capital. The cost to fund this will be greater for Proposal B, so this is a legitimate concern. Choice "c" is incorrect. Customers may feel they should be given the extended terms. If this is granted, the additional working capital need will be even greater. Choice "d" is incorrect. Banks may require that days sales outstanding cannot exceed a certain number of days. If so, it will be harder to meet this covenant with Proposal B.

• Question 34:

  Which one of the following statements is most correct if a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle? The seller:

  A. Will have a lower level of accounts receivable than those companies whose credit period is shorter than the purchaser's operating cycle.

  B. Is, in effect, financing more than just the purchaser's inventory needs.

  C. Is, in effect, financing the purchaser's long-term assets.

  D. Has no need for a stated discount rate or credit period.

  Correct Answer: B

  Choice "b" is correct. If a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle, the seller is, in effect, financing more than just the purchaser's inventory needs. Choice "a" is incorrect. Accounts receivable would be higher than those companies whose credit period is shorter than the purchaser's operating cycle. Choice "c" is incorrect. Seller is financing the purchaser, but not necessarily long-term assets. Choice "d" is incorrect. It is appropriate for the seller to have stated policies for discount rate and credit periods.

• Question 35:

  A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in the amount of bad debts, and a decrease in the investment in accounts receivable. Based upon this information, the company's:

  A. Average collection period has decreased.

  B. Percentage discount offered has decreased.

  C. Accounts receivable turnover has decreased.

  D. Working capital has increased.

  Correct Answer: A

  Choice "a" is correct. Average collection period has decreased due to a change in credit policy that has caused:

  1.

  Increase in sales,

  2.

  Increase in discounts taken,

  3.

  Decrease in the amount of bad debt; and

  4.

  Decrease in the investment in accounts receivable

  Choice "b" is incorrect. Percentage discount offered has probably increased, as discounts taken has

  increased.

  Choice "c" is incorrect. Accounts receivable turnover has increased, as sales are up and accounts

  receivable are down.

  Choice "d" is incorrect. Change in gross profit and working capital is not determinable from these facts.

• Question 36:

  A company with $4.8 million in credit sales per year plans to relax its credit standards, projecting that this will increase credit sales by $720,000. The company's average collection period for new customers is expected to be 75 days; and the payment behavior of the existing customers is not expected to change. Variable costs are 80 percent of sales. The firm's opportunity cost is 20 percent before taxes. Assuming a 360-day year, what is the company's benefit (loss) on the planned change in credit terms?

  A. $28,800

  B. $144,000

  C. $120,000

  D. $126,000

  Correct Answer: C

  Choice "c" is correct. $120,000 benefit on the planned change in credit standards.

  

  This question pertains to the economic benefit associated with a change in credit terms.

  The question tells us that the credit sales will increase by $720,000 if we relax our credit terms. We know

  variable costs are 80%, so we will earn $144,000 as a result of the expanded sales. The 20% contribution

  margin is equal to the 20% opportunity cost so there is no better investment of our resources for the

  expanded credit sales relative to its margin.

  What about the variable costs, though?

  We have $576,000 in variable costs that will be outstanding, pro rata, 75 days of the year. So the

  resources we will use to produce our sales is 75/360ths of $576,000, or $120,000 at any given time during

  the year. These $120,000 in resources could earn 20% annual return or $24,000. The $24,000 opportunity

  cost, compared to the $144,000 margin results in a $120,000 benefit in relaxing credit terms.

  Choices "a", "b", and "d" are incorrect, per the above calculation/discussion.

• Question 37:

  The average collection period for a firm measures the number of days:

  A. After a typical credit sale is made until the firm receives the payment.

  B. It takes a typical check to "clear" through the banking system.

  C. Before a typical account becomes delinquent.

  D. In the inventory cycle.

  Correct Answer: A

  Choice "a" is correct. The average collection period for a firm measures the number of days after a typical

  credit sale is made until the firm receives the payment.

  Choice "b" is incorrect. "Float" measures the number of days it takes a typical check to "clear" through the

  banking system.

  Choice "c" is incorrect. "Credit period (term)" measures the number of days before a typical account

  becomes delinquent.

  Choice "d" is incorrect. "Average days sales in inventory" measures the number of days in the inventory

  cycle.

• Question 38:

  An organization would usually offer credit terms of 2/10, net 30 when:

  A. The organization can borrow funds at a rate less than the annual interest cost.

  B. The cost of capital approaches the prime rate.

  C. Most competitors are not offering discounts, and the organization has a surplus of cash.

  D. Most competitors are offering the same terms, and the organization has a shortage of cash.

  Correct Answer: D

  Choice "d" is correct. Offering favorable credit terms is usually a response to either competitive forces in the market or to improve cash flow. Choice "a" is incorrect, although the payment terms of AR is a form of borrowing (or lending) to customers, companies are more likely to extend credit terms because of competitive pressures rather than because it represents a cheaper form of borrowing. Choice "b" is incorrect. The cost of capital at (or approaching) the prime rate is irrelevant without additional information. Choice "c" is incorrect. If most competitors are not offering discounts or credit terms, there is no reason to offer them. Also, if there is a surplus of cash, there is no reason to accelerate accounts receivable collection by offering credit terms.

• Question 39:

  The following information regarding a change in credit policy was assembled by the Wilson Wax Company. The company has a required rate of return of 10 percent and a variable cost ratio of 60 percent.

  

  The pretax cost of carrying the additional investment in receivables, using a 360-day year, would be:

  A. $5,760

  B. $9,600

  C. $8,160

  D. $960

  Correct Answer: A

  Choice "a" is correct.

  Step 1 Determine the average accounts receivable balance and the additional accounts receivable as

  follows:

  

  Therefore, the accounts receivable balance is $96,000 higher under the new credit policy.

  Step 2 Determine the additional INVESTMENT in the additional accounts receivable.

  Although Wilson has an additional $96,000 in accounts receievable, Wilson's actual investment in the

  additional accounts receivable is only 60% of $96,000 (because variable costs are 60% of sales). Wilson's

  investment in the additional accounts receivable is calculated as follows:

  $96,000 x 60% = $57,600

  Step 3 Calculate the cost of carrying the additional accounts receivable.

  Wilson's additional investment in accounts receivable is $57,600 and we are given a 10% required rate of

  return. This means that Wilson's carrying cost of $5,760 is calculated as follows:

  $57,600 x 10% = $5,760

  Choices "b", "c", and "d" are incorrect, per the above calculation.

• Question 40:

  A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction in the investment in accounts receivable, and a reduction in the number of doubtful accounts. Based upon this information, we know that:

  A. Net profit has increased.

  B. The average collection period has decreased.

  C. Gross profit has declined.

  D. The size of the discount offered has decreased.

  Correct Answer: B

  Choice "b" is correct. Whenever accounts receivable (AR) are decreasing when sales are increasing (and the decrease in AR is not due to an increase in bad debt write offs), this would indicate that the average collection period for AR has decreased. Choices "a", "c", and "d" are incorrect. There is insufficient information in the question to draw conclusions about these items.