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AICPA Exam CPA-Business Topic 1 Question 64 Discussion
Topic #: 1
Handyman Inc. operates a chain of hardware stores across New England. The controller wants to determine the optimum safety stock levels for an air purifier unit. The inventory manager has compiled the following data.
* The annual carrying cost of inventory approximates 20 percent of the investment in inventory.
* The inventory investment per unit averages $50.
* The stockout cost is estimated to be $5 per unit.
* The company orders inventory on the average of ten times per year.
* Total cost = carrying cost + expected stockout cost.
* The probabilities of a stockout per order cycle with varying levels of safety stock are as follows.
The total cost of safety stock on an annual basis with a safety stock level of 100 units is:
Choice 'a' is correct. 7.0 percent cost of funds from retained earnings.
The cost of retained earnings is equal to the rate of return required by the firm's common shareholders (or, in effect, the return 'lost' by them when the firm chooses to fund with retained earnings). While oftentimes this rate is somewhat subjective, we are given the facts to exactly answer the question in this case. The stock is currently selling for $100/share, and the dividend is given at $7/share.
$7 / $100 = 7%
Choices 'b', 'c', and 'd' are incorrect, per the above Explanation:/calculation.
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