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?

Explanation / Answer

Current number of orders = 120,000/10,000 = 12 orders
Current ordering cost = 12 x 200 = $2,400 per year
Current holding cost = (10,000/2) x 1 = $5,000 per year
Annual cost of components = $900,000 per year
Inventory cost without discount= 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
The revised ordering cost will be 4 x 200 = $800 per year
The revised holding cost will be (30,000/2) x 2·2 = $33,000 per year
The annual cost of components will be 120,000 x 7·50 x 0·964 = $867,600 per year
Inventory cost using discount = 867,600 + 800 + 33,000 = $901,400 per year

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