[infinity]

Perhaps it’s been a long day but I just didn’t understand why my answer was not correct.

I took 60,000 x $0.60= $36,000 x(11/12)=$33,000

$33,000 x 8% = $2,640

Why is the opportunity cost an average balance?

American Coat Company estimates that 60,000 special zippers will be used in the manufacture of men’s jackets during the next year. Reese Zipper Company has quoted a price of $.60 per zipper. American would prefer to purchase 5,000 units per month, but Reese is unable to guarantee this delivery schedule. In order to ensure availability of these zippers, American is considering the purchase of all 60,000 units at the beginning of the year. Assuming American can invest cash at eight percent, the company’s opportunity cost of purchasing the 60,000 units at the beginning of the year is:

$1,320.

$1,440.

$1,500.

$2,640.

Choice “1” is correct. Lost interest earnings of $1,320 represents the opportunity cost and is computed as follows:

Cost to purchase 60,000 zippers

60,000 zippers × $.60 per zipper = $36,000

The opportunity cost is the forgone interest on the $33,000 cash payment. (Computed 36,000 − 3,000, the first $3,000 would have had to be paid at the beginning of the month in either case.)

The invested cash is the average balance available for investment. Some $33,000 is available at the beginning of the year and is reduced by $3,000 per month for the remainder of the year until no cash is available in the final month. The average balance not invested is estimated at $33,000/2.

Principal

Rate

Time

Interest

($33,000 / 2)

×

.08

×

12 / 12

=

$ 1,320

Choices “2”, “3”, and “4” are incorrect, per the computations above.

BEC 74

Never give up, never surrender.

[M.O.D.]

Your calculation implies that the company pays interest for 11 months, but the difference is not that much because each month that passes reduces the amount.

Option 1

pays 36000 x .08 = 2880 interest opportunity cost upfront

Option 2

pays 5000x.6 = 3000 month 1 = interest of 240 (unavoidable)

month 2 = 240×2 = 480

.

.

month 12 = 240 x 12 = 2880

if you average months 2 to 12 you get 1320 too

Why average? Because that is how annual interest is calculated on a uniform changing principal through the year. Otherwise you would have to calculate for each month, its own interest rate.

period 1: 300 x 10%/3 = 30/3

period 2: 200 x 10%/3 = 20/3

period 3 100 x 10%/3 = 10/3

total = 600/3 = 60/3

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[M.O.D.]

Your calculation implies that the company pays interest for 11 months, but the difference is not that much because each month that passes reduces the amount.

Option 1

pays 36000 x .08 = 2880 interest opportunity cost upfront

Option 2

pays 5000x.6 = 3000 month 1 = interest of 240 (unavoidable)

month 2 = 240×2 = 480

.

.

month 12 = 240 x 12 = 2880

if you average months 2 to 12 you get 1320 too

Why average? Because that is how annual interest is calculated on a uniform changing principal through the year. Otherwise you would have to calculate for each month, its own interest rate.

period 1: 300 x 10%/3 = 30/3

period 2: 200 x 10%/3 = 20/3

period 3 100 x 10%/3 = 10/3

total = 600/3 = 60/3

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[mla1169]

The reason your answer is not correct is that you wouldn't be earning interest on the entire $33k for those 11 Months. You'd be paying evenly throughout the year and by the last month you would have paid the final 3k and lost no interest.

So month 2 would be interest lost on 30k, then 27k, and so on.

FAR- 77
AUD -49, 71, 84
REG -56,75!
BEC -75

Massachusetts CPA (non reporting) since 3/12.

[mla1169]

The reason your answer is not correct is that you wouldn't be earning interest on the entire $33k for those 11 Months. You'd be paying evenly throughout the year and by the last month you would have paid the final 3k and lost no interest.

So month 2 would be interest lost on 30k, then 27k, and so on.

FAR- 77
AUD -49, 71, 84
REG -56,75!
BEC -75

Massachusetts CPA (non reporting) since 3/12.

[Author]

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