One source of cash savings for a company is improved management of inventory. To illustrate, assume that Polaris and Arctic Cat both have $ 1,000,000 per month in sales of one model of snowmobiles in Canada, and both forecast this level of sales per month for the next 24 months. Also assume that both Polaris and Arctic Cat have a 20% contribution margin, their fixed costs are equal, and that cost of goods sold is the only variable cost. Assume that the main difference between Polaris and Arctic Cat is the distribution system. Polaris uses a just in time system and requires ending inventory of only 10% of next month's sales in inventory at each month end. However, Arctic Cat is building an improved distribution system and currently requires 30% of next month's sales in inventory at each month end.
Required:
1. Compute the amount by which Arctic Cat can reduce its inventory level if it can match Polaris' system of maintaining an inventory equal to 10% of next month's sales.
2. Explain how the analysis in part 1 that shows ending inventory levels for both the 30% and 10% required inventory policies can help justify a just in time inventory system. Assume a 15% interest cost for resources that are tied up in ending inventory.