A construction company maintains an average inventory of $150,000 in materials with an annual inventory carrying cost rate of 25%. What is the annual carrying cost?
Correct Answer
B) $37,500
Annual carrying cost = Average inventory × Carrying cost rate = $150,000 × 25% = $37,500. This includes costs for storage, insurance, obsolescence, and capital tied up in inventory.
Why This Is the Correct Answer
The annual carrying cost is calculated by multiplying the average inventory value by the carrying cost rate. This straightforward percentage calculation gives us $150,000 × 0.25 = $37,500. The carrying cost rate of 25% represents all costs associated with holding inventory including storage space, insurance premiums, potential obsolescence, and the opportunity cost of capital invested in materials.
Why the Other Options Are Wrong
Option A: $25,000
$25,000 would result from incorrectly using a rate of approximately 16.7% instead of the given 25% rate, or from some other calculation error.
Option C: $50,000
$50,000 would result from incorrectly using a rate of approximately 33.3% instead of the given 25% rate, possibly confusing this with a different cost percentage.
Option D: $62,500
$62,500 would result from incorrectly using a rate of approximately 41.7% instead of the given 25% rate, which is significantly higher than typical carrying cost rates.
Memory Technique
Remember 'ICC' - Inventory × Carrying rate = Carrying cost. Think of it as 'I See Costs' when you multiply these two numbers together.
Reference Hint
Look up inventory management and carrying costs in the business management or cost accounting sections of your contractor reference materials.
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