Cat Co places monthly orders with a supplier for 10,000 components which are use
ID: 2782455 • Letter: C
Question
Cat Co places monthly orders with a supplier for 10,000 components which are used in its
manufacturing processes. Annual demand is 120,000 components. The current terms are payment
in full within 90 days, which Cat Co meets, and the cost per component is $7.50. The cost of
ordering is $200 per order, while the cost of holding components in inventory is $1.00 per
component per year. The supplier has offered a discount of 3.6% on orders of 30,000 or more components. If the bulk
purchase discount is taken, the cost of holding components in inventory would increase to $2.20 per
component per year due to the need for a larger storage facility
1. What is the current total annual cost of inventory?
2. What is the total annual inventory cost if Cat Co orders 30,000 components at a time?
3. Cat Co has annual credit sales of $25 million and accounts receivable of $5 million. Working capital is financed by an overdraft at 10% interest per year. Assume 365 days in a year. What is the annual finance cost saving if Cat Co reduces the collection period to 60 days (to the nearest whole number)?
Explanation / Answer
Current number of orders = 120,000/10,000 = 12 orders
Current ordering cost = 12 × 200 = $2,400 per year
Current holding cost = (10,000/2) × 1 = $5,000 per year
Annual cost of components = $900,000 per year
Inventory cost under current policy = 900,000 + 2,400 + 5,000 = $907,400 per year
To gain the bulk purchase discount, the order size must increase to 30,000 components.
The number of orders will decrease to 120,000/30,000 = 4 orders per year T
he revised ordering cost will be 4 × 200 = $800 per year
The revised holding cost will be (30,000/2) × 2.2 = $33,000 per year
The annual cost of components will be 120,000 × 7.50 × 0.964 = $867,600 per year I
nventory cost using discount = 867,600 + 800 + 33,000 = $901,400 per year
Cat Co will benefit financially if it takes the bulk discount offered by the supplier, as it saves $6,000 per year in inventory costs or 0.66% of current inventory costs.
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