Corporate Finance – BA303
Tutorial 8 (Answers)
Corporate Finance – BA303
Questions 1-3 Are Multiple-Choice Questions, 4-8 Are Theory Questions And 9 & 10 Are
Calculation Questions
1. If EOQ = 40 units, order costs are $2 per order, and carrying costs are $0.20 per unit, what
is the usage in units?
(i) 10 units.
(ii) 16 units.
(iii)40 units.
(iv) 80 units.
2. Which of the following best represents the optimal economic order quantity (EOQ),
where total usage of the inventory item is 100,000 units for the planning period, the cost
per order is $180, and the carrying costs per unit for each period is $1?
(i) 6,000 units.
(ii) 4,243 units.
(iii)556 units.
(iv) 4 units.
3. If EOQ = 1,000 units, order costs are $200 per order, and sales total 5,000 units, what is
the carrying cost per unit?
(i) $2
(ii) $10
(iii)$100
(iv) $1,000
4. Why should companies offer trade credit ?
Answer:
▪ Investment and marketing. Trade credit should be viewed as an investment forming
part of the sales package, the payoff being profitable repeat business.
▪ Industry and competitive pressures. It is difficult for firms to offer credit terms that
are less generous than their competitors’ offerings.
▪ Finance. Certain types of firm have better access to capital markets and can raise
finance more cheaply than others.
▪ Efficiency. Information asymmetry exists between buyer and seller.
5. What is the aim of trade credit management ?
Answer:
The aims of trade credit management are the following:
■ To safeguard the firm’s investment in debtors.
■ To maximise operational cash flows by assessing customer credit risks, agreeing
appropriate terms and collecting payments in accordance with these terms.
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Corporate Finance – BA303
6. What are the main factors influencing credit period ?
Answer:
The main factors influencing the period of credit granted to customers are:
▪ The normal terms of trade for the industry.
▪ The importance of trade credit as a marketing tool.
▪ The individual credit ratings of customers.
7. What should credit assessment involve ?
Answer:
Credit assessment should involve the following:
▪ Prior experience with the particular customer.
▪ Analysis of the customer’s accounts and credit reports.
8. Why do company provide cash discounts to their customers in trade credit ?
Answer:
Cash discounts are financial inducements for customers to pay accounts promptly.
9. The treasurer of Bizarre plc, a company specializing in unusual gifts for eccentric business
managers has a sizeable sum invested in short-term investments, earning 6% interest. Every
time she sells investments to top up the bank balance, the transaction cost is £25. Monthly
cash payments are around £200,000. How often and by how much, should she transfer
money to the bank account ?
Answer :
The EOQ model gives an indication of the most economic amount of cash to be
drawn each time:
EOQ = ((2 x annual cash payments x cost of selling securities)/(annual interest
rate))0.5 = ((2 x £2,400,000 x £25)/0.06)0.5 = £44,721
The frequency with which the treasurer will transfer cash is 54 times a year (£2.4
mill/£44,721).
10. EOQ analysis. Tiger Corporation purchases 1,200,000 units per year of one component.
The fixed cost per order is $25. The annual carrying cost of the item is 27% of its $2 cost.
a. Determine the EOQ under each of the following conditions:
(i) No changes,
(ii) Order cost of zero, and
(iii)Carrying cost of zero.
b. What do your answers illustrate about the EOQ model? Explain.
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Corporate Finance – BA303
Answer:
