IFM10 Ch23 Solutions Manual

IFM10 Ch23 Solutions Manual - Chapter 23 Other Topics in...

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Chapter 23 Other Topics in Working Capital Management ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS 23-1 The Economic Ordering Quantity (EOQ) model combines the annual costs associated with ordering different quantities with the annual costs of carrying different average inventory balances. Ordering costs decline with larger orders, but larger orders mean larger average inventory balances, which mean larger carrying costs. The EOQ model finds the optimal order size, defined as the order size that minimizes the total annual costs of ordering and carrying inventories. The BOC Excel model illustrates the EOQ model. The EOQ model operates on the premise that it is costly to place and receive orders, that delays occur between ordering and receiving inventories, and that it is necessary to have stocks of inventories to avoid business stoppages. Those conditions hold for some firms, and for them the EOQ model makes sense as a way to think about inventory issues. For other firms, however, an alternative concept, the just-in-time (JIT) procedure, is more appropriate for many firms. JIT operates on the theory that firms can work with their suppliers in a “supply chain” sense so as to minimize inventory holdings at all levels of the supply chain. Manufacturing procedures must generally be modified to go from an EOQ to a just-in-time framework, and manufacturers throughout the chain must share plans and cooperate fully to derive the benefits of just-in-time procedures. Everything must function smoothly, including the quality of parts received from suppliers, for just- in-time to work. There are, of course, overlaps between the two approaches to inventory management, but they really involve different mind-sets, so they are more different than they are similar. 23-2 William Baumol modified the EOQ inventory model and applied it to cash management. He treated the transactions cost of either selling marketable securities or borrowing to replenish the cash balance as ordering costs in an EOQ sense, and in his model the income lost by holding non-earning or low-earning cash balances is equivalent to EOQ carrying costs. Baumol’s approach had much to recommend it in the pre-computer days, but today sophisticated treasurers use electronic methods to move money around, to borrow with extremely low transactions costs on an almost real-time basis, and to sell securities with low costs and on short notice. Cash management has moved beyond EOQ and the Baumol model. Answers and Solutions: 23 - 1
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23-3 Inventories used must be charged to cost of goods sold, which is subtracted from sales to produce gross operating profit. The four primary methods used to value inventory are these: (1) Specific identification, where each item’s cost is recorded and used as the cost of goods sold when the item is sold. Autos on a dealer’s lot are an example. (2) First in, first out (FIFO). (3) Last in, last out (LIFO). (4) and weighted average cost. If prices were stable in the senst that each unit of inventory cost the same amount as any other
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IFM10 Ch23 Solutions Manual - Chapter 23 Other Topics in...

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