carrying costs

Examples of carrying costs in the following topics:

• Economic Order Quantity Technique

  • Economic order quantity is the order quantity that minimizes total inventory holding costs and ordering costs.
  • This is not the cost of goods), H = annual holding cost per unit (also known as carrying cost or storage cost) (warehouse space, refrigeration, insurance, etc., usually not related to the unit cost).
  • Total Cost = purchase cost + ordering cost + holding cost
  • Purchase cost: This is the variable cost of goods: purchase unit price × annual demand quantity.
  • Ordering cost: This is the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year.

• Dangers Involved in Inventory Management

  • The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns, and defective goods and demand forecasting.
  • In addition, excessive inventory incurs extra handling costs and holding costs.
  • Inventory control - inventory cost elements (holding cost, order cost, total)Parameters: Order-cost (C) 10, demand (D) 1000, holding cost (i) 20% (of price), price (p) 10 => EOQ = 100

• Benefits of Inventory Management

  • Improved inventory management can lead to increased revenue, lower handling and holding costs, and improved cash flows.
  • The scope of inventory management concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods, and demand forecasting.
  • Management of the inventories, with the primary objective of determining/controlling stock levels within the physical distribution system, functions to balance the need for product availability against the need for minimizing stock holding and handling costs.
  • All of these practices leads to optimal product storage, helping minimize holding and handling costs.
  • This also saves handling and holding costs.

• Limitations of the Balance Sheet

  • Fixed assets are shown in the balance sheet at historical cost less depreciation up to date.
  • Depreciation affects the carrying value of an asset on the balance sheet.
  • The historical cost will equal the carrying value only if there has been no change recorded in the value of the asset since acquisition.
  • Historical cost is criticized for its inaccuracy since it may not reflect current market valuation.
  • Different methods of depreciation affect the carrying value of an asset on balance sheets.

• The Cost of Preferred Stock

  • The cost of preferred stock is equal to the preferred dividend divided by the preferred stock price, plus the expected growth rate.
  • The cost of preferred stock is 13%.
  • Because preferred stock carries a differing amount of risk than other types of securities, we must calculate its asset specific cost of capital to work into our overall weighted average cost of capital.
  • If preferred dividend is known and fixed, we can use the following equation to calculate the cost of capital for preferred stock .
  • The cost of preferred stock is equal to the preferred dividend divided by the preferred stock price, plus the growth rate.

• The Cost of Common Equity

  • The cost of equity is the return on equity that is required in order to compensate investors for the risk they undertake.
  • While a firm's current cost of debt is relatively easy to determine from observation of interest rates in the capital markets, its current cost of equity is unobservable and must be estimated.
  • The CAPM shows that the cost of equity is equal to the risk free rate plus a premium expected for risk.
  • Another approach to calculating the cost of common stock is to add a risk premium to the cost of debt.
  • The risk premium is the additional rate that must be paid to common shareholders above what is paid to bond holders, given the amount of risk carried by the equity.

• Market Value vs. Book Value

  • In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance.
  • An asset's initial book value is its its acquisition cost or the sum of allowable costs expended to put it into use.
  • In many cases, the carrying value of an asset and its market value will differ greatly.
  • Ways of measuring the value of assets on the balance sheet include: historical cost, market value or lower of cost or market.
  • Historical cost is typically the purchase price of the asset or the sum of certain costs expended to put the asset into use.

• Trade-Off Consideration

  • Trade-off considerations are important because they take into account the cost and benefits of raising capital through debt or equity.
  • The trade-off theory of capital structure refers to the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits.
  • It states that there is an advantage to financing with debt—the tax benefits of debt, and there is a cost of financing with debt—the cost of financial distress including bankruptcy.
  • The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases.
  • Of course, using equity is initially more expensive than debt because it is ineligible for the same tax savings, but becomes more favorable in comparison to higher levels of debt because it does not carry the same financial risk.

• Tax Deductions

  • What is the after-tax cost of a $1,000 of deductible expense?
  • After-tax cost = 1,000 x (1-0.35), so after-tax cost = 650
  • Nearly all jurisdictions that tax business income allow tax deductions for expenses incurred in trading or carrying on the trade or business.
  • An example of an ordinary expense is interest paid on debt, or interest expense incurred by a corporation in carrying out its trading activities.
  • To determine the after-tax cost of a deductible expense, we simply multiply the cost by one minus the appropriate marginal tax rate .

• Approaches to Assessing Risk

  • Since planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful.
  • As risk carries so many different meanings, there are many formal methods used to assess or to "measure" risk.
  • From the average cost per employee over time, or cost accrual ratio, a project manager can estimate: the cost associated with the risk, if it arises, estimated by multiplying employee costs per unit time by the estimated time lost (cost impact, C where C = cost accrual ratio * S), the probable increase in time associated with a risk (schedule variance due to risk, Rs where Rs = Probability * S).
  • The probable increase in cost associated with a risk (cost variance due to risk, Rc where Rc = P*C = P*Cost Accrual Ratio*S = P*S*CAR): sorting on this value puts the highest risks to the budget first, which can raise concerns about schedule variance.