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Homework answers / question archive / 1)M Inc
1)M Inc. is in the process of establishing its optimal safety stock quantity and has provided you the following data:
Supplier’s net invoice price P2,000
Carrying cost rate 5%
No. of orders per year 12
Stock out costs per occurrence P4,300
Probability of stock out:
Safety stock Probability
0 90%
100 60%
200 40%
300 25%
400 10%
Determine the following:
2. Cortana Co. feels that its credit costs are too high. By tightening its credit standards, bad debts will fall from 5% to 2%, but sales will fall from P100,000 to P90,000 per year. The variable cost per unit is 60% of the sales price, and the average investment in receivables is expected to remain unchanged. The effective tax rate is 30%. What is the net benefit or cost because of the tightening of the credit standards?
1.
a. Carrying cost per unit of safety stock
Safety Stock Carrying cost at 5% of net invoice price
0 0
100 10000 (100*2000*5/100)
200 20000 (200*2000*5/100)
300 30000 (300*2000*5/100)
400 40000 (400*2000*5/100)
b. Determination of Optimal safety stock and its total safety stock quantity cost.
Safety stock can be set at the level of 200. Since the order per year is only 12 safety stock can be kept minimum. Since the level of 100 is having a probability of stock out of 60% it can be ignored and choose the next level that is 200 which is only having 40% of stock our probability. No other upper levels are choosen since it will unnecesserily increase the cost.
Total safety stock quantity cost is as follows
Unit cost for 200 units - 400000 (200*2000)
Carrying cost at 5% - 20000 (200*2000*5/100)
Total cost - 420000
c. Assuming an 80% probability of stock out it is preferred to keep safety level just below 100 as it only has 60% of stock out probability. Therefore it is advisable to keep a level of saftey stock quantity between 90-70.
2.
Sales of cortana co will fall from 100000 to 90000 if it tighten its credit policy. But it will imrpove the profitability of the firm.
Normal Sales - 100000
less : Tax @ 30% - 30000 (100000*30/100)
less : variable cost @ 60% - 60000
less : bad debts @ 5% - 5000(100000*5/100)
Net profit - 5000 (100000-30000-60000-5000)
If sales decreased :
Sales : 90000
less : tax @ 30% - 27000 (90000*30/100)
less : varibale cost @ 60% - 54000 (90000*60/100)
less : bad debts @ 2% - 1800 (90000*2/100)
Net profit - 7200 (90000-27000-54000-1800)
It is evident from the above calculations that if the average investment in receivables is expected to remain unchanged and the firm tightens its credit standars, it will improve the net profit even though the sales volume drops by 10%. Therefore it is an advisable plan to tighten the credit standards.
