Thornton Manufacturing Company obtains its raw materials from a variety of suppl
ID: 411521 • Letter: T
Question
Thornton Manufacturing Company obtains its raw materials from a variety of suppliers. Thornton's strategy is to obtain the best price by letting the suppliers know that it buys from the lowest bidder. Approximately four years ago, unexpected increases in demand resulted in materials shortages. Thornton was unable to find the materials it needed even though it was willing to pay premium prices. Because of the lack of raw materials, Thornton was forced to close its manufacturing facility for two weeks. Its president vowed that her company would never again be at the mercy of its suppliers. She immediately ordered her purchasing agent to perpetually maintain a one-month supply of raw materials. Compliance with the president’s orders resulted in a raw materials inventory amounting to approximately $1,700,000. Warehouse rental and personnel costs to maintain the inventory amounted to $8,600 per month. Thornton has a line of credit with a local bank that calls for a 13 percent annual rate of interest. Assume that Thornton finances the raw materials inventory with the line of credit.
A. Required Based on the information provided, determine the annual holding cost of the raw materials inventory.
***Please provide step by step instructions***
Explanation / Answer
It is to be noted that before ordering for holding one month’s worth of inventory by President, there was no requirement of warehouse.
Requirement of warehouse has come in only after company has started maintaining inventory.
Thus, Cost of warehouse rental and associated personnel cost should be considered as part of annual inventory holding cost .
Annual cost of warehouse rental and associated personnel cost = $8600 / month x 12 months = $103200
Value of perpetual inventory at warehouse = $1,700,000
Annual cost of capital ( i.e. rate of interest ) = 13 %
Therefore , annual cost of carrying inventory = 13% of $1,700,000 = $221,000
Therefore , annual holding cost of raw material inventory
= Annual cost of warehouse rental and associated personnel cost + annual cost of carrying inventory
= $103200 + $221000
= $324200
ANNUAL HOLDING COST OF RAW MATERIAL INVENTORY = $324200
ANNUAL HOLDING COST OF RAW MATERIAL INVENTORY = $324200
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