AICPA Exam CPA-Business Topic 1 Question 64 Discussion

Actual exam question for AICPA's CPA-Business exam

Question #: 64
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:

A$1,750

B$1,950

C$2,000

D$650

Show Suggested Answer

Suggested Answer: A

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.

by Cordelia at Jan 05, 2023, 09:24 AM

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Francoise

6 days ago

So, the controller wants to know the optimal safety stock level for air purifiers, huh? I guess they're trying to keep the air in those stores as clean as the books. Maybe they should consider adding a few extra units just in case the accountants get a little too... purified.

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Stephen

8 days ago

Hmm, let's see. Carrying cost, stockout cost, probability of a stockout... Sounds like a recipe for a perfectly balanced financial statement. And if the inventory manager has their way, we'll be seeing a lot of purified air in those stores!

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Anisha

11 days ago

Okay, time to put on my best accountant hat. The carrying cost is easy, $1,000. The stockout cost is a bit trickier, but with a probability of 0.001 and a cost of $5 per unit, that's $0.05 per unit. Add those together and... voila, $1,000.05! Wait, is that the right answer? *scratches head*

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Karrie

12 days ago

Let's see, the carrying cost is 20% of $50 per unit, so $10 per unit. With 100 units, that's $1,000. The expected stockout cost is $5 per unit times the probability of 0.001, which is $0.05 per unit. With 100 units, that's $5. The total cost is $1,000 + $5 = $1,005. Aha, I got it!

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Shawna

24 days ago

Hmm, I think the key here is the probability of a stockout. With 100 units of safety stock, the probability is 0.1%. So the expected stockout cost is $5 x 0.001 = $0.05. Add that to the carrying cost of $1,000, and the total cost is $1,000 + $0.05 = $1,000.05. Not quite right, but closer.

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Gladis

10 days ago

A) $1,750

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Glendora

1 months ago

Okay, let's break this down. The carrying cost per unit is 20% of $50, which is $10. With a safety stock of 100 units, the carrying cost is $10 x 100 = $1,000. The expected stockout cost is 0.001 x $5 = $0.05 per unit, with 100 units that's $0.05 x 100 = $5. The total cost is $1,000 + $5 = $1,005. Definitely not the correct answer.

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