Question

1.   A manufacturing firm has the following estimates for its inventory:
   • 100,000 oz. of silver (D) is required for production each month
   • Ordering Costs are $50.00/order (OC)
   • Holding Costs are $1/oz. (HC)

1. Calculate the EQQ based on the information;
2. What’s the total cost at this EQQ units

2. What are some major considerations in extending trade credit?

What’s the five C’s of credit approval?

3. A firm has made a credit sales with the following credit terms:

• $2,000,000 order, 30-day credit terms
• VCR (0.30) = Variable cost ratio/$ of sales
• EXP (0.05/CP) = Expenses for credit administration and collection/$ of sales
• i (0.10/365) = Daily interest rate
• CP (45 days) = Collection period for sale

1. Calculate the variable cost of this sales
2. Calculate the present value of this sales
3. Calculate the NPV of this sales

Answer 1

a) EOQ means "Economic Order quantity" and is the ideal order quantity that a company should purchase to minimizes the total holding costs and ordering costs.

In order to calculate, the EOQ =2SD/H

where, S = Ordering cost

D = Monthly quantity demanded

H = Holding Cost

So, EOQ = 2*50*1,00,000/1 = 3,162.278 approx.

b) Total cost at EOQ point = Ordering Cost + Holding Cost

where, Ordering cost = Number of orders per month * Cost per order

= D*S/Volume per order

= 1,00,000*50/3162.278 = 1,581.139 approx

and, Holding Cost = Average Unit * Holding Cost per unit

   = 3,162.278/2 * 1 = 1,581.139 approx

Therefore, Total cost at EOQ point = 1,581.139 + 1,581.139 = 3,162.278 approx.

There are some major considerations in order to extend the credit :

I) Credit qualification : First, a one has to decide to whom the credit is to be given or extension must be granted i.e. consumers or businesses ? A list of criteria must be decided to whom the extension should be given. If it is consumer,simple credit application may be ask for references and further it can be check through consumer credit agency and if it is business customers, it can be check through business credit agencies.

II) Credit Policy : Prepare a credit policy that includes the whole process while extending credit to customers from application submission to the past due collection.

III) Credit Terms : Under this it has to be decided that how much credit and how long it should be extended to afford to wait the payment so that business operations will not be affected. The terms may vary all the way from 10-day to 90 day etc.It varies business to business.

IV) Credit Risk : It defines that it needs to check the risk willing to accept. Other financial resources are available to run the transactions if amount has not been received within this period of time. Or proper backup has been made to overcome the current situation.

V) Credit Review : Regular reviews should be conducted after extending the credit to observe the number of purchases of a particular customer. After review, it may consier increasing the credit limit, especially if the customers requests and has a solid payment record.