It seems some of the biggest news on the US economy comes from a July report of business inventories. They are up! A full 1 % rise in inventories has optimists looking for a brighter sales record to continue as well. Inventory levels were slashed during the recession and have been slowing expanding in the last year. However, the 1% July inventory increase was significantly larger than expected.
Business inventories are managed carefully as carrying costs have a compelling impact on the bottom line. Carrying costs include finance, insurance, security, spoilage, storage, handling, property taxes and other related costs associated with carrying inventory. These costs are soemtimes divided into four categories: finance costs, ownership costs, risk costs and overhead costs. From these it is clear the cost of inventory goes far beyond the initial product cost from the supplier.
Opportunity costs are a factor for business inventory levels as well. Although not treated as a cost on a financial statement, the decisions companies make with where to invest their capital send distinct messages to economists and industry experts. It provides an insight into companies' decision making processes and may indicate future economic conditions. It is the opportunity cost with inventory that adds importance to the July inventory report. Rather than investing capital in other areas, businesses are betting on sales and as such are beefing up inventory levels. This provides a hopeful insight into a possible continued economic expansion.
Sample Test Question: Task 1-B-4
Masford Company's board has been presented with options for business expansion. One option is to expand inventory levels across all product lines, which will require borrowing at 9% interest. Another option is to invest in a new product with an expected return of 12%. Mashford Coporation's board decided to invest in additional inventory this month. Using the opportunity cost approach, the cost to finance the inventory is:
A) 12%
B) 9%
C) 3%
D) 21%
1 comment:
Using the cost opportunity approach, the cost to finance the inventory is A) 12%.
Another approach for determining finance costs is the interest rate (9%). But the question specifically stated to use "the opportunity cost approach". This cost is determined by using the rate of return if investments are made elsewhere in the organization. In this case that is investment in a new product which is expected to return 12%.
Answer C), the difference between the two numbers, and answer D) the sum of the two numbers are thrown in for confusion sake.
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