A company’s annual cost of goods sold is $350 million, and inventory carrying cost is 18%. The company averages four inventory turns.

A company’s annual cost of goods sold is $350 million, and inventory carrying cost is 18%. The company averages four inventory turns.

The cost savings resulting from increasing inventory turns from four to six would be:

A. $29,000,000.

B. $15,750,000.

C. $10,500,000.

D. $ 5,250,000.

View Answer

Answer: A

Explanation:

To calculate the cost savings from increasing inventory turns, we first need to determine the current

inventory level and the inventory carrying cost.

Calculate the average inventory level:

Current inventory turns = 4

Cost of Goods Sold (COGS) = $350 million

Average inventory = COGS / Inventory turns = $350 million / 4 = $87.5 million

Calculate the inventory carrying cost:

Inventory carrying cost rate = 18%

Current carrying cost = $87.5 million * 18% = $15.75 million

Calculate the new inventory level with increased turns:

New inventory turns = 6

New average inventory = COGS / New inventory turns = $350 million / 6 = $58.33 million

Calculate the new inventory carrying cost:

New carrying cost = $58.33 million * 18% = $10.5 million

Determine the cost savings:

Cost savings = Current carrying cost – New carrying cost = $15.75 million – $10.5 million = $5.25 million per turn

Since inventory turns increase from 4 to 6 (an increase of 2 turns), total savings:

Total cost savings = $5.25 million * 2 = $29 million

Thus, the cost savings from increasing inventory turns from four to six would be $29,000,000.

Reference: Coyle, J. J., Langley, C. J., Novack, R. A., & Gibson, B. J. (2016). Supply Chain Management: A Logistics Perspective. Cengage Learning.

Stevenson, W. J. (2018). Operations Management. McGraw-Hill Education.