A contractor needs to establish a 6-month operating expense reserve. Monthly expenses are: payroll $18,000, insurance $2,500, equipment payments $4,200, and office expenses $1,800. What should the reserve fund total?
Correct Answer
B) $159,000
Monthly expenses = $18,000 + $2,500 + $4,200 + $1,800 = $26,500. Six-month reserve = $26,500 × 6 = $159,000. This reserve helps ensure business continuity during slow periods.
Why This Is the Correct Answer
Option B is correct because it properly calculates the total monthly operating expenses and multiplies by 6 months. The calculation adds all four expense categories ($18,000 + $2,500 + $4,200 + $1,800 = $26,500) then multiplies by 6 months ($26,500 × 6 = $159,000). This represents a complete 6-month operating expense reserve that covers all essential business costs during potential slow periods or cash flow interruptions.
Why the Other Options Are Wrong
Option A: $132,000
Option A ($132,000) represents only 5 months of operating expenses ($26,500 × 5 = $132,500, rounded), which falls short of the required 6-month reserve period specified in the question.
Option C: $145,500
Option C ($145,500) appears to be missing one of the expense categories or uses an incorrect monthly total, resulting in approximately 5.5 months of reserves rather than the full 6 months required.
Option D: $138,600
Option D ($138,600) calculates to approximately 5.2 months of operating expenses, indicating either incomplete expense categories were included or an arithmetic error in the monthly total calculation.
Memory Technique
Remember 'PIEO' - Payroll, Insurance, Equipment, Office - to ensure you include all four major operating expense categories before calculating reserves
Reference Hint
Business and Finance chapter covering cash flow management, operating expense calculations, and reserve fund requirements for contractors
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