Cat Co places monthly orders with a supplier for 10,000 components which are use

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

1) Current total annual cost of inventory = Cost of components + Yearly order cost + Cost of holding components in inventory = (120000*$7.50)+($200*12)+(120000*$1.00) = 900000+2400+120000 = $10,22,400.00 Cost of inventory 2) Inventory in 1st month 30000 components 22000 Inventory in 2nd month 20000 components 14666.66667 Inventory in 3rd month 10000 components 7333.333333 Inventory ordered in 1st month is 30000 components. So inventiry for 1st month would be 30000 components. Inventory for 2nd month would be 20000 components as 10000 components would have been sold in the 1st month. Inventory for 3rd month would be 10000 components as 20000 components would have been sold in the 1st and 2nd month. The cycle will continue for 4 times in the year as yearly requirement is of 120000 components. So total cost of inventory would be $22000+$14667+7333 Total cost of inventory = $44000

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