Q1-

Durham-Feltz Corporation presently gives terms of net 30 days. It has $60 million
in sales, and its average collection period is 45 days. To stimulate demand, the
company may give terms of net 60 days. If it does instigate these terms, sales
are expected to increase by 15 percent. After the change the average collection
period is expected to be 75 days, With no difference between payment habits in
old and new customers. Variable costs are $0.80 for every $1 sales, and the company's
required rate of return on investment in receivables is 20 percent. Should the company
extend its credit period ? (Assume a 360-day year).
Ans1-
Data
Current Situation: Proposed Situation:
Terms 30 days 60 days
Sales 60,000,000 69,000,000
Average Collection period 45 days 75 days
A/R Turnover 8 4.8
Accounts Receivable 7,500,000
Variable costs 0.8
Req. ROR 0.2
Increase in Sales 9,000,000
0- Increase in profitability (9M X 0.2) 1,800,000 (a)
1- New level of Receivables 12,500,000
associated with current sales
(60M / 4.8)
2- Current Receivables 7,500,000
associated with current sales
(60M / 8)
3= (1-2) Incremental receivables 5,000,000
4- Incremental investment 1,875,000
associated with
Receivables
(9M/4.8)
5- Variable cost associated 1,500,000
(1.875 X 0.8)
6= (3+5) Total Receivables 6,500,000
7- Total carrying Cost of receivables 1,300,000 (b)
(6.5 X 0.2)
8- (7-0) Profit 500,000 (c)
Q2-
Matlock Gauge Company makes wind and current gauges for pleasure boats.
The gauges are sold throughout the southeast to boat dealers, and the average
order size is $50. The company sells to all credit dealers with a credit analysis.
Terms are net 45 days, and average collection period is 60 days, which is regarded
as satisfactory. Jane Sullivan, the vice president, is now uneasy about the increasing
number of bad-debt losses on new orders. With credit ratings from local and regional
credit agencies, she feels she would be able to classify new orders into one of the three
risk categories. Past experience shows the followings:
Order Category
LOW
RISK
Bad debt loss 1%
Percent of Category order to total orders 30
The cost of producing and shipping gauges and of carrying the receivables is 78
percent of sales. The cost of obtaining credit rating information and of evaluating
is $4 per order. Surprisingly, there does not seem to be any association between
the risk category and the collection period. The average of each of three risk category
is around 60 days. Based on this information should the company obtain credit
information on new orders instead of selling to all new accounts without credit analysis?
Ans2-
Cost of producing and shipping 78%
gauges and of carrying the receivables
Profit 22%
As the bad debt losses for the high risk (i.e. 24%) category exceeds the profit margin
of 22 percent, it would be desirable to reject orders from this class if such orders
could be identified. However, the cost of credit information, as a percentage of the
average orders, is $4/50 = 8%, and this cost is applicable to all new orders. As the
high risk class is one fifth of the sales, the comparison would be 5% X 8% = 40%,
relative to bad debt losses of 24%, therefore, the company should not undertake
credit analysis of the new orders.
An example can better illustrate the solution if we assume new orders were $100,000.
the following would occur.
Order Category
LOW MEDIUM HIGH
RISK RISK RISK
Total Orders 30000 50000 20000
bad debt losses 300 2000 4800
No. of orders = Total Amount 100,000 $
Price per orders 50 $
= 2000
Credit analysis cost = No. of orders X Cost of credit information
= 2000 X $4 8,000 $
Conclusion: To save $4,800 in bad debt losses by identifying high-risk category of new
order, the company must spend $8,000. Therefore, it should not undertake the credit
analysis of the new orders.
Here the order size is too small to be worthy and justify the credit analysis. The new
order is accepted, the company will gain experience and can reject subsequent orders
if the experience is bad.
number of bad-debt losses on new orders. With credit ratings from local and regional
credit agencies, she feels she would be able to classify new orders into one of the three
Order Category
MEDIUM HIGH
RISK RISK
4% 24%
50 20
the risk category and the collection period. The average of each of three risk category
information on new orders instead of selling to all new accounts without credit analysis?
As the bad debt losses for the high risk (i.e. 24%) category exceeds the profit margin
An example can better illustrate the solution if we assume new orders were $100,000.
Conclusion: To save $4,800 in bad debt losses by identifying high-risk category of new
order, the company must spend $8,000. Therefore, it should not undertake the credit
Here the order size is too small to be worthy and justify the credit analysis. The new
order is accepted, the company will gain experience and can reject subsequent orders
Q3-
Vostick Filter Company is a distributor of air filters to retail stores. It buys its
filters from several manufacturers. Filters are ordered in lot size of 1,000, and
each order costs $40 to place. Demand from retail stores is 20,000 filters per
month, and carrying cost is $0.10 per filter a month.
a- What is the order quantity with respect to so many lot sizes ?
b- What would be the optimal order quantity if the carrying costs were $0.5 a
filter per month?
c- What would be the optimal order quantity if ordering costs were $10 ?
Ans3a-
Economic Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost
CC = carrying Cost OR
=
Ans3b-
Economic Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost
CC = carrying Cost OR
=
Ans3c-
Economic Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost
CC = carrying Cost OR
=
Vostick Filter Company is a distributor of air filters to retail stores. It buys its
filters from several manufacturers. Filters are ordered in lot size of 1,000, and
each order costs $40 to place. Demand from retail stores is 20,000 filters per
month, and carrying cost is $0.10 per filter a month.
a- What is the order quantity with respect to so many lot sizes ?
b- What would be the optimal order quantity if the carrying costs were $0.5 a
c- What would be the optimal order quantity if ordering costs were $10 ?
4000 Filert
OR
4 Lots
2 /
= 2 20000 40/0.10
5657 Filert
OR
5.657 Lots
2 /
= 2 20000 40/0.050
2000 Filert
OR
2 Lots
2 /
= 2 20000 10/0.10
Q4-
To reduce production startup costs, Bodden Truck Company may manufacture
longer runs of the same truck. Estimated savings from the increase in efficiency
are $260,000 per year. However, inventory turnover will decrease from eighth times
a year to six times a year. Costs of goods sold are $48 million on an annual basis.
If the required rate of return on investment in inventories is 15 percent, should
the company instigate the new production plan?
Ans4-
Inventory = Cost Of Goods Sold
Inventory Turnover
Current Situation = 48,000,000 6,000,000
8
Proposed Situation = 48,000,000 8,000,000
6
2,000,000
Investment in inventories (2,000,000 X 0.15) 300,000
(Opportunity cost)
Savings from increase in efficiency 260,000
Since savings increase from the costs associated 40,000 -
the company should not instigate the plan
are $260,000 per year. However, inventory turnover will decrease from eighth times
a year to six times a year. Costs of goods sold are $48 million on an annual basis.
If the required rate of return on investment in inventories is 15 percent, should
Prob1
To increase the sales from there present annual $24 million Jefferson Knu Monroe
Company, a wholesaler may, try more liberal credit standards. Currently the firm
has average collection period of 30 days. It believes that with increasingly liberal
credit standards, the following will result.
Credit Policy A
Increase in Sales 2.8
from previous level (in millions)
Average collection period for 45
Incremental sales (days)
The price of its product $20 per unit, and variable cost $18 per unit. No bad debt
losses are expected. If the company has pretax opportunity cost of funds of 30
percent, which credit policy should be pursued. (Assume 360 days)
Ans1- INCREMENTAL PROFITABILITY ANALYSIS
Credit Policy A
1- Increase in Sales (in '000') 2,800 $
2- Accounts Receivables Turnover 8
3- Additional Receivables 350
4- Additional Investment = 90% 315
(18/20 X Incremental Receivables)
5- Carrying Costs 94.50
(30% X Cost of receivables)
6- Incremental Profit/ Contribution 280
((20-18)/20 X Incremental Sales)
7- Net profit/ Loss 185.50
Conclusion: The company should pursue policy C because incremental profitability
increases for Policy A, B abd C but, not for policy D
To increase the sales from there present annual $24 million Jefferson Knu Monroe
Company, a wholesaler may, try more liberal credit standards. Currently the firm
has average collection period of 30 days. It believes that with increasingly liberal
B C D
1.8 1.2 0.6
60 90 144
The price of its product $20 per unit, and variable cost $18 per unit. No bad debt
losses are expected. If the company has pretax opportunity cost of funds of 30
percent, which credit policy should be pursued. (Assume 360 days)
INCREMENTAL PROFITABILITY ANALYSIS
B C D
1,800 $ 1,200 $ 600 $
6 4 2.5
300 300 240
270 270 216
81.00 81.00 64.80
180 120 60
99.00 39.00 4.80 -
Conclusion: The company should pursue policy C because incremental profitability
Prob2-
Upon reflection, Jefferson Knu Monroe Company has estimated that the
following pattern of bad debt losses will prevail if it initiates more
liberal credit terms.
Credit Policy A B C D
Bad debt losses on Incremental Sales 3% 6% 10% 15%
Given the other assumption in problem 1, which credit policy should be pursued ?
Ans2- INCREMENTAL PROFITABILITY ANALYSIS
Credit Policy A B C D
1- Increase in Sales (in '000') 2,800 $ 1,800 $ 1,200 $ 600 $
2- Accounts Receivables Turnover 8 6 4 2.5
3- Additional Receivables 350 300 300 240
4- Additional Investment = 90% 315 270 270 216
(18/20 X Incremental Receivables)
5- Carrying Costs 94.50 81.00 81.00 64.80
(30% X Cost of receivables)
6- Bad debt losses on incremental sales 84 108 120 90
(bad debt % X Incremental Sales)
7- Total Costs 178.50 189.00 201.00 154.80
8- Incremental Profit/ Contribution 280 180 120 60
((20-18)/20 X Incremental Sales)
9- Net profit/ Loss 101.50 9.00 - 81.00 - 94.80 -
Conclusion: Policy A is the only one where the incremental profitability exceeds
incremental carrying costs and the bad debt losses.
Prob3-
Recalculate the problem 2 assuming the following pattern of bad debt losses.
Credit Policy A B C D
Bad debt losses on Incremental Sales 1.5% 3.0% 5.0% 7.5%
Which policy is the best?
Ans3- INCREMENTAL PROFITABILITY ANALYSIS
Credit Policy A B C D
1- Increase in Sales (in '000') 2,800 $ 1,800 $ 1,200 $ 600 $
2- Accounts Receivables Turnover 8 6 4 2.5
3- Additional Receivables 350 300 300 240
4- Additional Investment = 90% 315 270 270 216
(18/20 X Incremental Receivables)
5- Carrying Costs 94.50 81.00 81.00 64.80
(30% X Cost of receivables)
6- Bad debt losses on incremental sales 42 54 60 45
(bad debt % X Incremental Sales)
7- Total Costs 136.50 135.00 141.00 109.80
8- Incremental Profit/ Contribution 280 180 120 60
((20-18)/20 X Incremental Sales)
9- Net profit/ Loss 143.50 45.00 21.00 - 49.80 -
Conclusion: With change in the bad debt losses pattern policy B would now
be the best.
Prob4-
The Chicke Corporation has 12% opportunity cost of funds and currently sales on
terms net 10, EOM. This means the goods shipped before the end of the month
must be paid for by the tenth of the following month. The firm has sales of $10
million a year, which are 80 percent on credit and spread evenly over the year.
Currently, the average collection period is 60 days. If Chike offered terms
2/10 net 30, 60 percent of its customers would take the discount and collection
period would reduced to 40 days. Should Chike change its terms from net/10 to 2/10
net 30? (Assume 360 days)
Ans4-
Data
Current Situation
Opportunity cost of funds
Sales
Credit Sales 80%
Terms
Collection period
Proposed Situation
Terms
Discount availed
Collection period
Credit Sales (10,000,000 X 0.8)
Accounts Receivable Turnover
Funds tiled up in receivables
Additional funds
Discount availed by the customers (8,000,000 X 0.6 X .02)
Return on reduction in receivables
Loss
Conclusion: It is definitely nor appropriate to have a change in the credit terms.
In fact change in bad debt losses should be investigated.
The Chicke Corporation has 12% opportunity cost of funds and currently sales on
terms net 10, EOM. This means the goods shipped before the end of the month
must be paid for by the tenth of the following month. The firm has sales of $10
million a year, which are 80 percent on credit and spread evenly over the year.
Currently, the average collection period is 60 days. If Chike offered terms
2/10 net 30, 60 percent of its customers would take the discount and collection
period would reduced to 40 days. Should Chike change its terms from net/10 to 2/10
12%
10,000,000
8,000,000
net 10
60 days
2/10 net 30
60%
40 days
Current Proposed
8,000,000 $ 8,000,000 $
6 9
1,333,333 888,889
444,444
Discount availed by the customers (8,000,000 X 0.6 X .02) 96,000
53,333
-42,667 $
Conclusion: It is definitely nor appropriate to have a change in the credit terms.
In fact change in bad debt losses should be investigated.
Prob5-
Porras Pottery Products Inc., spends $220,000 per annum on its collection
department. The company has $12 million in credit sales, its average
collection period is 2.5 months, and the percentage of bad-debt losses is
4 percent. The company believes that if it were to double its collection
personals, it could bring down the average collection period to 2 months and
bad debt losses to 3 percent. The added cost is $180,000, brining total
expenditures to $400,000 annually. Is the increased effort worthwhile if the
opportunity cost of funds is (a) 10 percent, (b) 20 percent? (assume a 360-day year.)
Ans5- Data
Current Situation
Sales 12,000,000
Expenditures of collection department 220,000
Average collection period 2.5 months
Bad debt losses 4 percent
Opportunity costs of funds 10 percent
Expenditures on collection department 220,000
bad debt losses (12M X 0.4) 480,000
700,000
Funds tied up in receivables 2,500,000
Proposed Situation (if the opportunity cost of the funds is 10 percent)
Average collection period 2 Months
Bad debt losses 3 percent
Additional Costs 180,000
Expenditures on collection department 400,000
bad debt losses 360,000
(12M X 0.3)
760,000
Funds tied up in receivables 2,000,000
Additional funds tied up (2,500,000 2,000,000) 500,000
Opportunity costs of funds (500,000 X0.10) 50,000
Additional Costs (760,000 - 700,000) 60,000
Since, costs exceed the return, the 10,000 -
proposal should not be accepted
Proposed Situation (if the opportunity cost of the funds is 10 percent)
Additional funds tied up (2,500,000 2,000,000) 500,000
Opportunity costs of funds (500,000 X0.20) 100,000
Additional Costs (760,000 - 700,000) 60,000
Since, costs is less than the return, the 40,000
proposal should be accepted
Alternate Solution
Present Situation Proposal 1 Proposal 2
1- Annual Sales 12,000,000 12,000,000 12,000,000
2- Receivable Turnover 4.8 6.0 6.0
3- Receivable Level 2500000 2000000 2000000
4- Reduction from the
present level 500000 500000
5- Return on reduction 50000 100000
6- Bad Debt Losses % 4% 3% 3%
7- Bad Debt Losses 480,000 360,000 360,000
8- Reduction n Bad debt losses 120,000 120,000
9- Total Savings (5 +8) 170,000 220,000
10- Incremental Costs 180,000 180,000
11- Net profit/ Loss (9-10) 10,000 - 40,000
Prob6-
The Pottville Manufacturing Corporation is considering extending credit to the
San Joe Company. Examination of the records of San Joe has produced the
following financial statements.
San Joe Company Balance Sheet (In million)
Assets
Current Assets
Cash
Receivables
Inventories (at lower of cost or market)
Other
Total Current Assets
Fixed Assets
Building (net)
Machinery and Equipment (net)
Total Fixed Assets
Other Assets
Total Assets
Liabilities and Shareholders' Equity
Current Liabilities
Trade payable
Notes payable
Other payable
Total Current Liabilities
Term Loan
Total Liabilities
Shareholders' Equity
Common Stock
Preferred Stock
Retained Earnings
Total Liabilities and Equity
The San Joe Company has a Dun & Bradstreet rating of 4A-2. Inquires into it banking
disclosed balances generally in the low seven figures. Five suppliers to San Joe revealed
that the firm takes its discount from three offerings, 2/10 net 30 terms, and it is about
15 days late in paying the two firms offering terms of net 30.
San Joe Company Income Statement (In million)
Net Credit Sales
Costs of Goods Sold
Gross Profit
Operating expenses
Net profit before taxes
Taxes
Profit after taxes
Dividends
Total Income
Analyze the San Joe Company's application for credit. What positive factors are
present? What negative factors are present?
Ans6- Positive Factors
1- The firm has maintained reasonably good cash position over the period.
2- The company has reduced by 50% its outstanding long-term debt.
3- The firm has been increasing its shareholders' equity by $1 million Annually.
4- The company has offered cash discounts when offered.
Negative Factors
1- The company has only a fair D & B rating.
2- It has been a slow player to trade creditors who do not offer discounts.
3- The liquidity of the firm has been reduced over the past 3 years, as the acid-test ratio went
from 1.28 to 1.05 to 0.92. Short term debt and trade payables have increased significantly,
while inventory turnover and receivable turn over have decreased.
4- The age of the trade payables has increased dramatically (about 400%)
5- The profitability of the firm has declined over the past three years.
6- The firm passed its dividends in 20X3 which may indicate a financial problem..
The Pottville Manufacturing Corporation is considering extending credit to the
San Joe Company. Examination of the records of San Joe has produced the
San Joe Company Balance Sheet (In million)
20X1 20X2 20X3
1.5 1.6 1.6
1.3 1.8 2.5
1.3 2.6 4.0
0.4 0.5 0.4
4.5 6.5 8.5
2.0 1.9 1.8
7.0 6.5 6.0
9.0 8.4 7.8
1.0 0.8 0.6
14.5 15.7 16.9
2.1 3.1 3.8
0.2 0.4 0.9
0.2 0.2 0.2
2.5 3.7 4.9
4.0 3.0 2.0
6.5 6.7 6.9
5.0 5.0 5.0
1.0 1.0 1.0
2.0 3.0 4.0
14.5 15.7 16.9
The San Joe Company has a Dun & Bradstreet rating of 4A-2. Inquires into it banking
disclosed balances generally in the low seven figures. Five suppliers to San Joe revealed
that the firm takes its discount from three offerings, 2/10 net 30 terms, and it is about
15 days late in paying the two firms offering terms of net 30.
San Joe Company Income Statement (In million)
20X1 20X2 20X3
15.0 15.8 16.2
11.3 12.1 13.0
3.7 3.7 3.2
1.1 1.2 1.2
2.6 2.5 2.0
1.3 1.2 1.0
1.3 1.3 1.0
0.3 0.3 -
1.0 1.0 1.0
Analyze the San Joe Company's application for credit. What positive factors are
1- The firm has maintained reasonably good cash position over the period.
2- The company has reduced by 50% its outstanding long-term debt.
3- The firm has been increasing its shareholders' equity by $1 million Annually.
4- The company has offered cash discounts when offered.
2- It has been a slow player to trade creditors who do not offer discounts.
3- The liquidity of the firm has been reduced over the past 3 years, as the acid-test ratio went
from 1.28 to 1.05 to 0.92. Short term debt and trade payables have increased significantly,
while inventory turnover and receivable turn over have decreased.
4- The age of the trade payables has increased dramatically (about 400%)
5- The profitability of the firm has declined over the past three years.
6- The firm passed its dividends in 20X3 which may indicate a financial problem..
Prob7-
The Quigley Company sells and installs ski lifts. It has received order from
Alpine Ski Resort for a $2.3 million system. The production and installation
costs of this system amounts to 69.6 percent of the total selling price.
Because Alpine wishes to go through a full session before paying for the system,
It has asked for credit terms of 1 year. Quigley estimates that there is 80 percent
probability that Alpine will pay in full and 20 percent chance that
it will go bankrupt and pay nothing at the end of the year. Alpine's hill will be
filled with this installation so there is no prospects for repeat orders. Quigley's
opportunity costs of carrying the receivables at its stated value of $2.3 million is
15 percent per annum.
a - On the basis of this information, should the Quigley accept the order ?
b- (1) if its costs were 74 percent of its selling price, would the order be accepted?
(2) If it were 65 percent?
Ans7a-
Selling Price 2,300,000
Present value of receivables to be 2,000,000
paid at the end of the year
(2,300,000 /1.15)
1- Expected present value of receivable allowing for bad debts
(2,000,000 X 0.8) 1,600,000
2- Costs of the system @69.6% 1,600,800
(2,300,000 X 69.6)
The costs are approximately equal, so Quigley will be indifferent
as to accept the order to not.
Ans7b1- If the costs are 65 percent
Selling Price 2,300,000
Present value of receivables to be 2,000,000
paid at the end of the year
(2,300,000 /1.15)
1- Expected present value of receivable allowing for bad debts
(2,000,000 X 0.8) 1,600,000
2- Costs of the system @74% 1,702,000
(2,300,000 X 69.6)
The order should be rejected since the costs exceed the expected
present value
Ans7b2- If the costs are 74 percent
Selling Price 2,300,000
Present value of receivables to be 2,000,000
paid at the end of the year
(2,300,000 /1.15)
1- Expected present value of receivable allowing for bad debts
(2,000,000 X 0.8) 1,600,000
2- Costs of the system @65% 1,495,000
(2,300,000 X 69.6)
The order should be accepted since the costs are less than
the expected present value
Prob8-
A college book store is attempting to determine the optimal order quantity for
a popular book on psychology. The store sells 5,000 copies of book a year at a
retail price of $12.50, although the publisher allows the store a 20 percent
discount on this price. The store figures that it costs $1 per year to carry a book of
inventory and $100 to prepare an order for new books.
a- Determine total costs associated with ordering 1, 2, 5, 10 and 20 times a year.
b- Determine the optimal order quantity.
Ans8a-
Total Cost = Ordering Cost + Carrying Cost + Cost price
(TC = OC + CC)
Ordering Cost = Total Units / EOQ X Cost per order
Carrying Cost = EOQ/2 X Carrying cost per Unit
Every 1 Time
Ordering Cost = (5000/5000X100) 100
Carrying Cost = (5000/2X1) 2500
Total Cost 2,600
Every 2 Time
Ordering Cost = (5000/2500X100) 200
Carrying Cost = (2500/2X1) 1250
Total Cost 1,450
Every 5 Time
Ordering Cost = (5000/1000X100) 500
Carrying Cost = (1000/2X1) 500
Total Cost 1,000
Every 10 Time
Ordering Cost = (5000/500X100) 1000
Carrying Cost = (500/2X1) 250
Total Cost 1,250
Every 20 Time
Ordering Cost = (5000/250X100) 2000
Carrying Cost = (250/2X1) 125
Total Cost 2,125
Optimal Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost 1000 dints
CC = carrying Cost Means every 5 time
2 /
= 2 5000 100/1
Prob9-
The hedge Corporation manufactures only one product; Plunk, The single raw
material used in making the Plnk is dint. For each Plunk manufactures, 12 dints
are required. Assumes the company manufactures 150,000 plunks per year, that
demand for Plunk is steady throughout the year, that it costs $200 each time dints
are ordered and that carrying costs are $8 per dint per year.
a- Determine the economic order quantity for dints.
b- What are the total inventory costs for Hedge (Carrying costs plus ordering costs)?
c- How many times per year would inventory be ordered ?
Ans9a-
Optimal Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost 9487 dints
CC = carrying Cost
Ans9b-
Total Cost = Ordering Cost + Carrying Cost
(TC = OC + CC)
Ordering Cost = Total Units / EOQ X Cost per order
Carrying Cost = EOQ/2 X Carrying cost per Unit
Ordering Cost = (150000X12)/9487 X 200 37,947
Carrying Cost = (9487/2) X8 37,948
Total Inventory Cost 75,895
Ans9c-
Total Units / EOQ = (150000X12)/9487 190
Approximately 190 days or 365/190 = after
every 2 days.
2 /
= 2 150000 12 200/8
b- What are the total inventory costs for Hedge (Carrying costs plus ordering costs)?
Prob10-
Favorite Foods, Inc., buys 50,000 boxes of ice cream every two month to service
steady demand for the products. Other costs are $100 per order and carrying
costs are $0.40 per box.
a- Determine the optimal order quantity.
b- The vendor now offers Favorite Foods Company a quantity discount of $0.02
per box if it buys cones in order size of 10,000 boxes. Should favorite Foods avail
itself of the quantity discount? (Hint: Determine the increase in carrying costs and
decrease in ordering costs relative to your answer in part a. Compare these with the
total savings available through the quantity discounts.
Ans11a-
Optimal Order Quantity =
RU = Required Units
OC = Ordering Cost
UC = Unit Cost
2
=
CC = carrying Cost
Ans3b-
Total Cost = Ordering Cost + Carrying Cost
(TC = OC + CC)
Ordering Cost = Total Units / EOQ X Cost per order
Carrying Cost = EOQ/2 X Carrying cost per Unit
If we accept the vendor's proposal, carrying cost would increase and
ordering cost would decrease size the order size is small. If the order
size had been large, it would be vice versa.
Incremental carrying cost = (10000-5000)/2 X 0.4
Savings in ordering cost = (50000/5000X100) - (50000/10000X100)
Savings in Quantity discount = (50000X0.02)
Net Incremental Savings
Conclusion:
Since, the incremental savings exceed the incremental cost, the company should accept
the quantity discount.
Favorite Foods, Inc., buys 50,000 boxes of ice cream every two month to service
steady demand for the products. Other costs are $100 per order and carrying
b- The vendor now offers Favorite Foods Company a quantity discount of $0.02
per box if it buys cones in order size of 10,000 boxes. Should favorite Foods avail
itself of the quantity discount? (Hint: Determine the increase in carrying costs and
decrease in ordering costs relative to your answer in part a. Compare these with the
total savings available through the quantity discounts.
5000
2 /
2 50000 100/0.40
Total Cost = Ordering Cost + Carrying Cost
Total Units / EOQ X Cost per order
EOQ/2 X Carrying cost per Unit
If we accept the vendor's proposal, carrying cost would increase and
ordering cost would decrease size the order size is small. If the order
Incremental carrying cost = (10000-5000)/2 X 0.4 -1,000 $
Savings in ordering cost = (50000/5000X100) - (50000/10000X100) 500 $
1,000 $
500 $
Since, the incremental savings exceed the incremental cost, the company should accept
Prob11-
Fouchee Scents Inc, makes various scents for use it the manufacture of food
products. Although the company does not maintain a safety stock, it has a
policy of "lean" inventories, with the results that customers sometimes must be
turned away. In an analysis of the situation, the company has estimated the cost
of being out of stock associated with various levels of safety stock"
Safety level of Safety Annual cost
Stock Level Stock ( In gallons) of stock out
Present 5000 26,000
New level 1 7500 14,000
New level 2 10000 7,000
New level 3 12500 3,000
New level 4 15000 1,000
New level 5 17500 -
Carrying costs are $0.65 per gallon per year. What is the best level of safety stock for
the company ?
Ans11-
1 2 3 4
Safety level of Safety Carrying costs Annual cost
Stock Level Stock ( In gallons) ( 2 X 0.65) of stock out
Present 5000 3250 26,000
New level 1 7500 4875 14,000
New level 2 10000 6500 7,000
New level 3 12500 8125 3,000
New level 4 15000 9750 1,000
New level 5 17500 11375 -
Conclusion:
The level of safety stock should be increased from 5,000 gallon to 15,000 gallon.
policy of "lean" inventories, with the results that customers sometimes must be
turned away. In an analysis of the situation, the company has estimated the cost
Carrying costs are $0.65 per gallon per year. What is the best level of safety stock for
5
Total Cost
( 3 + 4)
29,250
18,875
13,500
11,125
10,750
11,375
The level of safety stock should be increased from 5,000 gallon to 15,000 gallon.