Summary Sheet #5

C19:
 Costs associated with Goods for Sale: Purchasing costs, Ordering costs, Carrying costs, Stockout
costs, Costs of quality, Shrinkage costs
 Economic order quantity (EOQ): calculates the optimal quantity of inventory to order under a given
set of assumptions

 PO Lead Time: time to get the order in

 Safety stock: extra inventory held at all times above the quantity of inventory ordered
determined by the EOQ model

 Just-in-time (JIT) Procurement (demand-pull manufacturing system): Price and quality terms are
defined by long-term purchase agreements; Electronic links are used to place POs at a fraction of the
cost of a traditional method (reduce the cost of placing PO – smaller EOQ)
  Benefits of JIT:
1) Lower overhead costs - reduced need for materials handling, warehousing and inspection leads
2) Lower inventory levels - lower carrying costs of inventory
3) Focus on Quality - eliminating the specific causes of rework, scrap, and waste
4) Shorter manufacturing lead times

 Materials Requirements Planning (MRP): a push-through system that manufactures finished goods
for inventory on the basis of demand forecasts
1) MRP sources: Demand forecasts of final products, A bill of materials (detailing); The quantities of
materials, components, and product inventories
2) Takes into account lead time; Sets a master production schedule; output of each department is
pushed through the production line whether it is needed or not (may result in an accumulation of
inventory)
 Enterprise Resource Planning (ERP): Integrated set of software modules including accounting,
distribution, manufacturing, purchasing and human resources; a single database in real time
highlighting interdependencies and bottlenecks in business processes

C20:
 Payback: Measures the time it will take to recoup the net initial investment in a project; doesn’t
recognize the time value of money and doesn’t consider the cash flow past the payback
point

(when annual CFs are the same)

 Accrual Accounting Rate of Return Method (AARR or ARR): Fails to recognize the time value of
money and it does not track cash flows

 Time Value of Money; Discounted cash flow methods (NPV) use the required rate of return (RRR)
 Required rate of return (RRR) is also called discount rate, hurdle rate, cost of capital, opportunity
cost of capital
 If NPV = 0, the return on investment = the RRR; If NPV is greater than 0, the return on investment is
greater than the RRR; A negative NPV means that the project will not yield the RRR
 Internal Rate of Return (IRR): Calculates the discount rate at which the NPV = 0; Trial and error
approach; acceptable only if IRR >= RRR
 NPV is preferred compared to IRR; NPV is in dollars
 Major Types of Cash Flows: Initial invest; disposal; operating CFs that differ between alternatives;
Income tax impact
 Sensitivity Analysis when calculating NPV: what if assumptions and estimates change

 (1-Tax Rate) x Tax-deductible cash expense (Taxable cash receipt)

 Capital Cost Allowance (CCA) Tax Shield: depreciation under GAAP; not a cash flow but has an
indirect effect on cash flows which is why it must be included in NPV analysis; Half-year rule (first year)
 Unamortized capital cost, UCC= original capital expenditure – CCA claimed

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  PV of tax shield on CCA:

r= discount rate

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