Problem 16-7 Cost Trade-Offs in Short-Term Financial Management Geet Industries
ID: 2723563 • Letter: P
Question
Problem 16-7 Cost Trade-Offs in Short-Term Financial Management Geet Industries wants to install a just-in-time (JIT) inventory system in order to significantly reduce its in-process inventories. The annual cost of the system is gauged to be $91,000. The financial manager estimates that with this system, the firm's average inventory investment will decline by 37% from its current level of $2.05 million. All other costs are expected to be unaffected by this system. The firm can earn 14% per year on equal-risk investments. What is the annual cost savings expected to result from installation of the proposed JIT system? Round your answer to the nearest whole dollar. $ per year Should the firm install the system?
Explanation / Answer
Savings from decline in inventory = $2,050,000 x 37% = $758,500
(As the firm can earn 14% on equal-risk investment, this is the opportunity cost for the system and savings from system should be discounted by this rate to find out the actual worth)
Discounted value of Savings = $758,500 / 1.14 = $665,351