AICPA CPA-Business CPA Exam Practice Test Instant Access

Question 1

Williams, Inc. is interested in measuring its overall cost of capital and has gathered the following data. Under the terms described below, the company can sell unlimited amounts of all instruments.

* Williams can raise cash by selling $1,000, 8 percent, 20-year bonds with annual interest payments.

In selling the issue, an average premium of $30 per bond would be received, and the firm must pay floatation costs of $30 per bond. The after-tax cost of funds is estimated to be 4.8 percent.

* Williams can sell 8 percent preferred stock at par value, $105 per share. The cost of issuing and selling the preferred stock is expected to be $5 per share.

* Williams' common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7 per share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by $3 per share, and floatation costs are expected to amount to $5 per share.

* Williams expects to have available $100,000 of retained earnings in the coming year; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.

* Williams' preferred capital structure is:

Long-term debt 30%

Preferred stock 20

Common stock 50

The cost of funds from retained earnings for Williams, Inc. is:

A7.0 percent.

B7.4 percent.

C8.1 percent.

D7.8 percent.

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.

Question 2

Edwards Manufacturing Corporation uses the standard Economic Order Quantity (EOQ) model. If the EOQ for Product A is 200 units and Edwards maintains a 50-unit safety stock for the item, what is the average inventory of Product A?

A250 units.

B150 units.

C125 units.

D100 units.

Answer : B

Choice 'b' is correct. 150 units is the average inventory including a 50-unit safety stock.

Choices 'a', 'c', and 'd' are incorrect, per the above calculation.

Question 3

When the Economic Order Quantity (EOQ) model is used for a firm, which manufactures its inventory, ordering costs consist primarily of:

AInsurance and taxes.

BStorage and handling.

CProduction set-up.

DCost of funds.

Answer : C

Choice 'c' is correct. When the economic order quantity (EOQ) model is used for a firm that manufactures its own inventory, ordering costs consist primarily of production set-up.

Choices 'a', 'b', and 'd' are incorrect, per the above Explanation:.

Question 4

An example of a carrying cost is:

ADisruption of production schedules.

BQuantity discounts lost.

CHandling costs.

DObsolescence.

Answer : D

Choice 'd' is correct. Obsolescence is an example of a carrying cost.

Choices 'a', 'b', and 'c' are incorrect. Carrying cost is not:

A Disruption of production schedules.

B Quantity discounts lost.

C Handling costs.

Question 5

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

Answer : A

Choice 'a' is correct. $1,750 total annual cost of safety stock of 100 units.

Choices 'b', 'c', and 'd' are incorrect, per the above calculation.

Question 6

The sales manager at Ryan Company feels confident that if the credit policy at Ryan's was changed, sales would increase and, consequently, the company would utilize excess capacity. The two credit proposals being considered are as follows:

Currently, payment terms are net 30. The proposal payment terms for Proposal A and Proposal B are net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit policy would include all of the following factors, except the:

ACost of funds for Ryan.

BCurrent bad debt experience.

CImpact on the current customer base of extending terms to only certain customers.

DBank loan covenants on days sales outstanding.

Answer : B

Choice 'b' is correct. Because the bad debt percentage is the same under either of the two proposals, there is no differential cost associated with bad debt. Because it is not a differential cost, it is not considered in comparing the two alternatives.

Choice 'a' is incorrect. Because Proposal A and B have different net collection dates, Proposal B will cause a greater amount of accounts receivable with a corresponding increase in working capital. The cost to fund this will be greater for Proposal B, so this is a legitimate concern.

Choice 'c' is incorrect. Customers may feel they should be given the extended terms. If this is granted, the additional working capital need will be even greater.

Choice 'd' is incorrect. Banks may require that days sales outstanding cannot exceed a certain number of days. If so, it will be harder to meet this covenant with Proposal B.

Question 7

Which one of the following statements is most correct if a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle? The seller:

AWill have a lower level of accounts receivable than those companies whose credit period is shorter than the purchaser's operating cycle.

BIs, in effect, financing more than just the purchaser's inventory needs.

CIs, in effect, financing the purchaser's long-term assets.

DHas no need for a stated discount rate or credit period.

Answer : B

Choice 'b' is correct. If a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle, the seller is, in effect, financing more than just the purchaser's inventory needs.

Choice 'a' is incorrect. Accounts receivable would be higher than those companies whose credit period is shorter than the purchaser's operating cycle.

Choice 'c' is incorrect. Seller is financing the purchaser, but not necessarily long-term assets.

Choice 'd' is incorrect. It is appropriate for the seller to have stated policies for discount rate and credit periods.

AICPA CPA Business Environment and Concepts CPA Exam Practice Test