6.4 Review - Opportunity Costs in Managing Inventory and Work-in-Process Services

The consulting firm of Howe and Biggs is currently conducting a large consulting assignment for Spaeth Industries. Howe has calculated that the financial holding costs of this 3-month project are $6,000. If the project will use $600,000 in supplies, labor, and overhead, Howe's cost of capital must be:

$600,000 / 2 x 3/12 x CC = $6,000 CC = $6,000 / $75,000 CC = 8%

Portage Company made the following inventory purchases during the year: January 1 $ 80,000 March 31 $150,000 July 15 $172,000 October 1 $ 90,000 If Portage Company's cost of capital is 14%, what is the amount of its holding costs for the year?

Average amount of inventory ($80,000 + $150,000 + $172,000 + $90,000) / 4 purchased: = $123,000 Average investment in inventory: ($0 + $123,000) / 2 = $61,500 Holding costs: $61,500 x 1 x 14% = $8,610

Financial holding cost in a merchandising firm is calculated by which formula?

Average inventory investment × Annual rate × Number of periods

The private investigation firm of Watson & Holmes is conducting an investigation for a wealthy movie star. The investigation is estimated to take 6 months to complete and will use $2,000 in supplies, $120,000 in labor, and $80,000 in overhead. Watson & Holmes' cost of capital is 12%. What are the financial holding costs on this project?

Average investment: ($0 + $2,000 + $120,000 + $80,000) / 2 = $101,000 Financial holding costs: $101,000 x 6/12 x 12% = $6,060

Which of the following is an opportunity cost associated with financial holding costs?

Both too much inventory and too little inventory

Economic profit is:

Net operating profit − Financial holding costs

The private investigation firm of Watson & Holmes is conducting an investigation for a wealthy movie star. The investigation is estimated to take 6 months to complete and will use $2,000 in supplies, $120,000 in labor, and $80,000 in overhead. Watson & Holmes' cost of capital is 12%. At the end of the sixth month, Watson & Holmes finds that the investigation will take an additional 2 months to complete and another $80,000 in labor and overhead. What are the additional financial holding costs for the 2 extra months on this project?

Original work-in-process services: $2,000 + $120,000 + $80,000 = $202,000 Additional holding costs: [($202,000 + $282,000) / 2] x 2/12 x 2% = $4,840

Merchandising companies can have holding costs associated with merchandise inventory. In service firms, the account that would have a comparable holding cost would be:

Work-in-Process Services

The CPA firm of Peck, Williams, and Shafner is conducting an audit of Monolith Enterprises. The audit is estimated to take 4 months to complete and will use $4,000 in supplies, $200,000 in labor, and $320,000 in overhead. Peck's annual rate is 18%. What are the financial holding costs on this project?

[($0 + $4,000 + $200,000 + $320,000) / 2] x 4/12 x 18% = $15,720

The CPA firm of Peck, Williams, and Shafner is conducting an audit of Monolith Enterprises. The audit is estimated to take 4 months to complete and will use $4,000 in supplies, $200,000 in labor, and $320,000 in overhead. Peck's annual rate is 18%. At the end of the fourth month, Peck finds that the audit will take an additional 2 months to complete and another $200,000 in labor and overhead. What are the additional financial holding costs for the 2 extra months on this project?

[($524,000 + $724,000) / 2] x 2/12 x 18% = $18,720