(b) Cost of current inventory policy
Cost of materials = $540,000 per year
Annual ordering cost = 12 x 150 = $1,800 per year
Annual holding cost = 0·24 x (15,000/2) = $1,800 per year
Total cost of current inventory policy = 540,000 + 1,800 + 1,800 = $543,600 per year
Cost of inventory policy after bulk purchase discount
Cost of materials after bulk purchase discount = 540,000 x 0·98 = $529,200 per year
Annual demand = 12 x 15,000 = 180,000 units per year
KXP Co will need to increase its order size to 30,000 units to gain the bulk discount
Revised number of orders = 180,000/30,000 = 6 orders per year
Revised ordering cost = 6 x 150 = $900 per year
Revised holding cost = 0·24 x (30,000/2) = $3,600 per year
Revised total cost of inventory policy = 529,200 + 900 + 3,600 = $533,700 per year
Evaluation of offer of bulk purchase discount
Net benefit of taking bulk purchase discount = 543,600 – 533,700 = $9,900 per year
The bulk purchase discount looks to be financially acceptable. However, this evaluation is based on a number of unrealistic assumptions. For example, the ordering cost and the holding cost are assumed to be constant, which is unlikely to be true in reality. Annual demand is assumed to be constant, whereas in practice seasonal and other changes in demand are likely. |
